Patterns and Determinants of Payout Policy in the 21-st Century
A study of the Nordic Countries
Abubacarr Sidy Nyassi, Tatiana Silva da Costa
Department of Business Administration Master's Program in Accounting
Master's Thesis in Business Administration III, 30 Credits, Spring 2021 Supervisor: Jesper Haga
Abstract
Payout policies is one of the most discussed topics in corporate finance. Since Miller &
Modigliani (1961) dividend irrelevance theory, which was based on perfect markets, many theories have been developed in order to incorporate market imperfections to payout decisions. Numerous scholars have been trying to explain why companies pay dividends, whether they should compensate investors with alternative methods such as share repurchases or not distribute cash at all.
The theme has gained lots of attention during the 21-st century driven by the subprime financial crisis in 2008 and mostly recently, in 2020, due to economic impacts brought by the Covid 19 pandemic. Another important aspect that makes the study of payout policy relevant in the 21-st century is the unique impacts of unveiled trends such as globalization and volatile markets, increased importance of ecology and sustainability, emergency of fast growth firms (mainly in the Tech industry) and change characteristics of listed firms. Globally there is a tendency of reduction in the number of listed firms and also deterioration in the quality of earnings. Additionally, there is no consensus about which factors influence a firm propensity of distributing cash to shareholders, which makes the topic very intriguing. Previous research has been conducted mainly within US firms. Few studies have been conducted regarding payout policies in the Nordic countries and most of them give little attention to share repurchases and payout policy determinants.
Therefore, we decided to conduct a study regarding the patterns and determinants of payout policy in the 21-st century with focus on the Nordic countries.
The purposes of the study are: first, to understand the pattern of payout policies in the Nordic countries during the 21-st century and second determine if there is a relationship between a number of firm’s selected factors and firm’s payout policy. As a sub purpose we intend to examine whether the Covid 19 pandemic had any effect on Nordic firm’s payout policies. The factors investigated, namely: debt, profit, retained earnings, growth opportunities, cash holdings, size and age were identified through a detailed literature review. We collected data from Thomson Reuters DataStream Eikon covering the period between 2000 and 2020 for 1,153 firms from all Nordic countries: Denmark, Iceland, Finland, Norway and Sweden.
The study follows a quantitative research method with a deductive approach, and we have based the theoretical framework on the following theories: Miller-Modigliani dividend irrelevance theory, Signaling theory, Agency theory, Life-cycle theory and Substitution and Flexibility hypotheses. In order to determine whether there is a relationship between the companies selected factors and the payout ratios we conducted ordinary least square (OLS) correlation analysis. Additional regression analysis was conducted to verify possible impacts of Covid 19 on Nordic payout policies. Results indicate that some firms’
selected characteristics such as debt, size and age have an impact on Nordic firms’ payout policy during the 21-st century. Larger firms with lower debt are more willing to pay cash dividends, while older firms tend to present higher levels of share repurchase. Firms’
characteristics showed no impact on changes in payout ratios during the initial period of Covid 19.
Keywords: Firms’ factors, cash dividends, share repurchases, payout ratio, Dividend Irrelevance Theory, Signaling Theory, Agency Theory, Life-cycle Theory, Substitution and Flexibility Hypotheses.
Acknowledgments
We would like to thank our supervisor Jesper Haga for all support and feedback provided during the elaboration of this thesis. We thank each other for the pleasant teamwork and fruitful discussions. And finally, we would like to thank the Swedish Institute Scholarship that funded both of our Master Programs at Umeå University which made this publication possible.
Abubacarr Sidy Nyassi Tatiana Silva da Costa nyassi.sidy@gmail.com tatibh.costa@gmail.com
Table of Contents
1. Chapter: Introduction ... 1
1.1. Background ... 1
1.2. Problematization... 2
1.3. Research Question ... 3
1.4. Purpose ... 3
1.5. Delimitations ... 4
1.6. Contributions ... 4
2. Chapter: Methodology ... 6
2.1. Previous Understanding and Choice of Subject ... 6
2.2. Methodological Assumptions ... 6
2.3. Ontology ... 7
2.4. Epistemology ... 7
2.5. Research Approach and Method ... 8
2.6. Literature Search ... 9
2.7. Sources Criticism ... 10
3. Chapter : Theoretical Framework ... 11
3.1. Miller-Modigliani Dividend Irrelevance Theory ... 11
3.2. Signaling Theory ... 11
3.3. Agency Theory ... 13
3.4. Life-cycle Theory ... 14
3.5. Substitution and Flexibility Hypotheses ... 14
3.6. Summary of Theoretical Framework ... 15
3.7. Firms Selected Factors ... 16
3.7.1. Debt ... 17
3.7.2. Profit ... 18
3.7.3. Retained Earnings ... 19
3.7.4. Growth Opportunities ... 19
3.7.5. Cash Holdings ... 20
3.7.6. Size ... 21
3.7.7. Age ... 21
3.8. Payout Patterns ... 22
4. Chapter: Practical Method ... 24
4.1. Population, Sampling Frame & Sample ... 24
4.2. Data Collection ... 25
4.3. Data Processing ... 25
4.4. Statistical Analysis ... 26
4.4.1. Research Design... 26
4.4.2. Regression Analysis ... 26
4.4.3. Hypothesis Testing... 28
4.5. Ethics ... 28
4.5.1. Conflict of Interest & Affiliation Bias ... 29
4.5.2. Harm and Wrongdoing ... 29
4.5.3. Confidentiality and Anonymity ... 29
4.5.4. Misrepresentation ... 29
5. Chapter: Empirical Results ... 30
5.1. Descriptive Statistics ... 30
5.2. Payout Patterns ... 32
5.3. Multicollinearity ... 39
5.4. Regression Results ... 40
5.4.1. Regression Results by Country ... 41
5.5. Additional Results: Covid 19 period ... 44
6. Chapter: Discussion ... 46
6.1. Hypothesis ... 46
6.2. Covid 19 Period ... 49
6.3. Payout Patterns ... 50
7. Chapter: Conclusions ... 51
7.1. Conclusions ... 51
7.2. Practical and Theoretical Contribution ... 52
7.3. Societal Implications ... 53
7.4. Further Research ... 53
7.5. Truth Criteria ... 54
7.5.1. Reliability ... 54
7.5.2. Validity ... 55
8. Reference List ... i
Appendix 1 - Correlation Matrix, Cash dividend payout ratio ... v
Appendix 2 - Correlation Matrix, Share repurchases payout ratio ... v
Appendix 3 - Variables Definition ... vi
List of Figures Figure 1. Methodological Fit. Source Edmondson & McManus (2007), p. 1168. ... 9
Figure 2. Total earning, total payout, cash dividends and share repurchase. ... 36
List of Tables Table 1. Overview of selected studies. ... 17
Table 2. Descriptive Statistics of Nordic listed firms. ... 30
Table 3. Firms industry distribution by Thomson Reuters Business Classification (TRBC). . 32
Table 4. Annual observations relating to cash distribution to shareholders. ... 34
Table 5. Segregation of annual observations by cash dividends and share repurchases. ... 35
Table 6. Annual observations for firms first time cash distribution. ... 37
Table 7. Concentration of payments. ... 38
Table 8. VIF and tolerance test for Nordic listed firms. ... 39
Table 9. Results of multiple regressions. ... 40
Table 10. Results of multiple regressions by country. ... 43
Table 11. Payouts comparison between the years 2019 and 2020. ... 44
Table 12.Results of multiple regression for differences in payout ratios(2020/2019). ... 45
Table 13.Correlation matrix of cash dividend payout ratio and independent variables. ... v
Table 14. Correlation matrix of share repurchase payout ratio and independent variables. ... v
Table 15. Definition of variables used in regression analysis. ... vi
1
1. Chapter: Introduction
In this chapter we will start with an introduction to the research topic; the patterns and determinants of payout policies in Nordic countries during the 21-st century. The chapter presents previous research and central theories which leads to the research gap. We will thereafter present research question, purpose, delimitations, and contributions.
1.1. Background
Payout policy, which refer to the methods firms uses when distributing cash to shareholders, is a mature financial topic which has been extensively studied throughout history. More specifically, the use of dividends as a form to compensate shareholders is an old practice observed among many types of firms. One of the most famous theories about payout policies was published by Miller & Modigliani (1961) which asserts that in a perfect markets, payout policy is irrelevant to a firm's value. It also claims that considering that investors have rational behaviors, shareholders should be neutral about receiving dividends or stock returns. However, real markets have many imperfections such as asymmetric information costs and transaction costs. These imperfections served as a base to foment the development of other financial theories including signaling theory , agency cost theory, life-cycle theory and substitution and flexibility hypotheses. The discussion regarding the topic raises questions on why companies pay dividends, whether they should compensate investors with alternative methods such as share repurchases, or not distribute cash at all.
The theme has gained lots of attention during the 21-st century driven by the subprime financial crisis in 2008 and mostly recently, in 2020, due to the economic downturn caused by the Covid 19 pandemic. Evidences show that managers are usually reluctant to cut dividends because dividends reductions are viewed as a signal of poor future performance (Al-Malkawi, 2014;
Bhattacharya, 1979; Lintner’s, 1956). However, during the financial crises of the 21-st century, many firms announced reductions of dividends and in some cases the extinction of it. In early 2009, Standard & Poor’s data indicated that US firms cut dividends in the order of $58 billion.
On the top of that Bloomberg predicts that the dividends reductions in the second quarter of 2020 will be at record levels, surpassing the ones presented in the beginning of 2009 (Bloomberg, 2020). Yet some researchers (Al-Malkawi et al., 2014; Floyd et al., 2015) show empirical evidence that the 2008 financial crisis had an insignificant impact on firm payout policies and that banks had a higher resistance to cut dividends during crises. Another aspect that makes the study of payout policy relevant in the 21-st century is the unique impact of unveiled trends such as globalization and volatile markets, increased importance of ecology and sustainability, better corporate governance technologies with higher use of stock options (Fama & French, 2001, p. 40), increasing use of digital technologies, emerging of start-ups and fast growth firms (mainly in the Tech industry) and change characteristics of listed firms, which are currently small and present low profitability (Fama & French, 2001, p. 21).
Fama & French (2001, p. 40) shows evidence that the proportion of firms paying cash dividends have decreased over time and that disregarding firms’ attributes, they are less likely to pay dividends than in the past. However, DeAngelo et al. (2004, p. 426) shows that aggregate real dividends paid by industrial firms in the US has been increasing since 1978 and that there is a growing concentration in the supply of dividends. There are diverse results and a lack of
2 uniformity regarding payout policies, which make the topic very intriguing. As stated by Black (1976, p. 5) “dividends are like a puzzle, with pieces that do not fit together”. The theories presented in the literature were not able to completely solve the issues related to payout policies and even though many studies were conducted in the field, we believe some contributions are still necessary.
1.2. Problematization
As previously mentioned, dividend policies are still one of the most controversial and intriguing puzzles in corporate finance and many scholars have been trying to solve it for quite a long time (Baker et al., 2002, p. 242). The distribution of cash to shareholders in the form of dividends is a mature practice and since the 80’s, some firms have been also using share repurchases as a way to compensate investors (Fama & French, 2001, p. 6). Share repurchases, also known as buyback, are transactions on which a firm purchases shares from within the company’s shareholders and investors (Brealey et al., 2019, p. 426). Additionally, some successful companies with good financial performance even decide to not distribute cash at all.
This indicates that there is no linear practice among firms’ payout policies, and companies must have different reasons for why and how they define their payout policies.
The reasons why firms pay dividends has been broadly debated and one of the most influential theories was presented by Miller & Modigliani (1961). The authors argue that in perfect market conditions, dividends are irrelevant for shareholders wealth. Therefore, managers shouldn’t be much concerned about which dividend policy a firm chooses because it does not impact the company’s value. The theory states that the firm's value is impacted only by the earning power of a company's assets and its investment policy, and not by the payout policy (Miller &
Modigliani, 1961, p. 414). If this theory holds for real markets, firms would be indifferent to distributing cash to investors and the pattern of payouts would not be relevant.
Contradicting Miller & Modigliani theory regarding payout policy irrelevance, many researchers aim to explain why payout policy matters and argue that payout policy has an impact on a firm’s values. Lintner (1956, p. 108) indicates that payout decisions have informational content and managers are reluctant to reduce dividends. Also, the author describes a strong correlation between the current level of dividend rate and a target payout level that is based on the firm’s expected earnings stability. The view that dividends could send information to the market about a company's future performance is supported by other signaling studies (Bhattacharya, 1979; Miller & Rock, 1985), where informational asymmetry between managers and investors creates room for using dividend to signal the firm’s future performance. The firm’s payout policies are very relevant to investors and managers since it can impact a company's value and shareholders' wealth. Hence it is important that the firm’s stakeholders recognize the aspects that affect payout policies.
Jensen (1986) argues that conflict of interest between managers and shareholders are very relevant to payout policies especially in firms with considerable free cash flow. Therefore, shareholders tend to prefer receiving dividends from companies with excess free cash flows in order to reduce the agency costs (Jensen, 1986, p. 323). However, free cash flow is remotely the only factor that determines payout ratios. According to Miller & Rock (1985) the firm’s growth has an important role in the dividend payouts and Fama & French (2001) show evidence that profitability, investment opportunities and size affect the decision to pay dividends. Eije
& Megginson (2008) analysed data from Europe that indicates a correlation of a firm’s age and the likelihood of cash payouts. These studies revealed some examples of firm characteristics that may influence payout ratios, but they are of course not limited to these factors only. In this
3 study, we aim to use several determinants of payout policies identified in previous studies, such as debt, profit, retained earnings, growth opportunities, cash holdings, size and age. Those factors will be discussed in detail in section 3.7.
United States firms are the most studied regarding payout policies. Additionally, some studies covered firms in Europe and other countries such as Brazil, Canada and Japan. Many investigations have been done in order to identify which factors have a great influence on payout policies, especially focusing on dividend payments. However, the results express diverging evidence across different geographical regions. For example, Bildik et al. (2015) compares dividend payout patterns in the US and other 32 countries and finds that the proportion of companies that pay dividends in the US is lower than in the rest of the world.
Few studies have been conducted regarding payout policies in the Nordic countries and most of them give little attention to share repurchases.
Many academic efforts have been put into understanding the pattern of payout policies over time, more specifically on dividends payment. Studies have shown evidence that the proportion of dividend payers have decreased over time (Fama & French, 2001; Denis & Osobov, 2008), that the aggregate real dividends increased and that there is concentration among dividend payers (DeAngelo et al., 2004, p. 426). Brav et al. (2005) examines payout policies in the 21- st century until the year of 2002, and a considerable number of studies also covered the period of the 2008 subprime financial crisis, but there is still no consensus about the impact of the crisis on firm’s payout policies (Alcántara et al., 2020; Al-Malkawi et al., 2014; Floyd et al., 2015).
To the best of our knowledge there are few studies focusing in the Nordic region and they primarily explore dividend payments. Moreover, no studies have been conducted regarding patterns and determinants of payout policies in the Nordic countries focusing on the 21-st century, especially none of them covering the period of 2019-2020, which covers the Covid 19 pandemic crisis. We considered it a missed opportunity as the Nordic countries have a unique cultural and political background. Added to the unprecedented impacts of Covid 19 pandemic in the global economy, it constitutes a unique scenario to study the payout policy of the 21-st century. Therefore we think that it is interesting to conduct research regarding the payout policy pattern in the Nordic countries during this period and the relationship between a number of preselected firm’s factors and the payouts in the Nordic firms.
1.3. Research Question
This study aims to answer the following research question:
What are the patterns and determinants of payout policy in the Nordic countries during the 21- st century?
1.4. Purpose
This study has two main purposes: first we will investigate the pattern of payout policy in Nordic countries during the 21-st century; second, we will examine the relationship of firms characteristics such as debt, profit, retained earnings, growth opportunities, cash holdings, size and age to a company’s payout policy. As a sub-purpose, we intend to investigate whether the Covid 19 pandemic had an impact on listed Nordic firm’s payout policies.
4 1.5. Delimitations
In this section, we highlight some of the delimitations existent in this paper. Like other academic papers, we have limited our scope of study to a specific research area which is feasible according to our thesis calendar. In doing so, we enhanced our study to only capture factors that are most relevant to answering our research question. Therefore, we are going to discuss our paper delimitations.
This study is limited to information regarding public listed companies in all Nordic countries, namely Denmark, Finland, Iceland, Norway and Sweden, during the 21-st century. The reason for this is that no studies, to our knowledge, have explored the pattern and determinants of Nordic countries payout policies in the period between 2000 and 2020. The data used in the analysis was extracted from Thomson Reuters DataStream Eikon database (TRDE). Our sample excludes utility and financial firms, which comprises banks, insurance and investment funds. This is because firms in these sectors are subjected to high regulations, which could impact payout policies. Also, this approach is in line with other empirical studies (Eije &
Megginson, 2008; Fama & French, 2001; Jagannathan et al., 2000).
The timeframe of data collection seeks to examine payout patterns during the first two decades of the 21-st century. Accordingly, the data used in our analysis comprises the period between the year 2000 and 2020. The reason behind our decision to focus our study on this period is that the past two decades have captured different economic periods, including the 2001 recession caused by the tech bubble, the subprime global financial crisis in 2008 and recently, the Covid 19 pandemic. The pattern of the economic performance during this period therefore could reveal some effects on how companies roll out their payout decisions. It is worth mentioning that the Covid 19 pandemic is still developing at the time of writing this paper.
Therefore is hard to predict when it will be over and any future financial consequences that could result from it. Hence the study will only analyse the impact of Covid 19 during its initial phase from the end of 2019 to the end of 2020.
Moreover, our study will be limited to a number of firm’s characteristics namely debt, profit, retained earnings, growth opportunities, cash holdings, size and age. These variables have been selected due to their presence in previous literature which is discussed in detail in section 3.7.
Our analysis regarding payout policies includes share repurchases and dividends paid in cash, excluding all other forms of dividends such as scrip dividends. Lastly, we choose to remove tax considerations, due to the complexity of the topic and the fact that analyzing individual tax rules from different countries would not meet our time constraints for this study.
1.6. Contributions
As highlighted earlier, our study seeks to examine two main issues, the pattern of Nordic payout policy in the 21-st century, and the determinants of payout policies among listed firms in the Nordic region. Therefore, this study will add knowledge in the academic debate relating to firm payout policies, expanding it to the use of share repurchases which have not received much attention from previous studies. The main contributions will come from applying established methods when analyzing the relationship of firm characteristics and payout policies to the Nordic context. In general compared to studies covering the Nordic region, we will use a broader set of firms characteristics to identify their relationship with payout ratios in the Nordic listed firms. Our investigation of initial phase of Covid 19 will allow us to identify whether specific firms’ characteristics play a role in payout ratios during periods of financial distress and future uncertainty. Also, our findings will enable us to check whether existing theories
5 regarding payout policies are sufficient to explain Nordic countries payout practices. Majority of previous studies were focused on the US and other regions, so our results will potentially verify possible differences due to regional and cultural realities.
Furthermore, any findings from our work will also provide practical implications to both management of corporate firms and investors who consider payout policies when constructing portfolios. The findings will enable managers and decision makers of firms to have a clear understanding on the trend of payouts in the past two decades, thereby providing a good basis of comparison between firms. It will also provide managers with knowledge about the characteristics they should consider when planning for payout policies. For the external investors, our findings will enable them to understand the reasons why and how firms make payout decisions and plan their investments according to their preferences, if any, regarding payout behaviors.
6
2. Chapter: Methodology
In this chapter we will discuss exclusively the research philosophical standpoints we built upon during the course of our activity. The choice of subject will be presented, and the methodological assumptions used in the study will be discussed. We also presented an examination regarding the literature search and criticism of the sources used.
2.1. Previous Understanding and Choice of Subject
When conducting research, it is important that the authors recognize that previous experiences, assumptions and preconceptions can influence how the study is conducted (Saunders et al., 2016, p. 208).
The authors of this paper are master’s students at Umeå School of Business, Economics and Statistics. During our academic studies, we have undertaken a quite significant number of courses in accounting and financial management. These modules grounded us with a solid theoretical background on corporate finance and payout policy. Our interest in conducting this study emanated from in-class discussions on the missing pieces of the payout policy puzzle as highlighted by previous studies. Initially, our interest was to analyse the impact of financial crises on a company’s payout policy decisions, including the effects brought by the pandemic.
On the top of that, during the preliminary screening of articles, we noticed that some companies have reacted to the Covid-19 crisis by altering their payout policies. Based on these preliminary assumptions, we considered it worthwhile to pursue a study on patterns and determinants of payout policy in the 21-st century, specifically in the Nordic market where studies of payout policy have been overlooked.
Neither of the authors has directly engaged in practical decision making of payout policies, since none of us have worked as a Chief Financial Officer (CFO) or any other high manager position. However, one of the authors has performed few transactions related to trading stocks and one of the factors considered when choosing a portfolio was whether and how the firms distribute cash to shareholders. Even though the value of transactions was low, it added some practical understanding about payout policy. Considering we have little practical knowledge of payout policy decisions, we believe most of our understanding comes from different literatures such as books, courses and scientific articles. We are aware that our previous knowledge about the research field is an advantage and supports our selection, analysis and understanding of literature review.
2.2. Methodological Assumptions
The author’s methodological assumptions and research philosophy are very important when conducting research. These aspects are a set of beliefs and practices that influence how the researcher formulate the research question and the methods used to study a particular phenomenon (Morgan, 2007, p. 49-50). These standpoints are undoubtedly essential not only to the researcher, but also to all relevant stakeholders of the research activity. Therefore, we believe it is important to inform our views regarding knowledge in order to provide the reader a better understanding of the research strategy and approach. The next subsections detail our position regarding ontological and epistemological views which guided this research.
7 2.3. Ontology
Ontology refers to philosophical standpoints assumed by researchers regarding the nature of social reality (Long et al., 2000, p. 190). Ontological questions are prior to the research activity because they simply deal with the nature of being (Marsh & Furlong, 2002, p. 18). Therefore, the researcher’s ontological position holds a direct influence on the research process and its outcomes. There are two main different ontology positions: objectivism and subjectivism.
Under objectivism, researchers view the social world as operating according to natural laws (Long et al., 2000, p. 192) and social reality is independent of our knowledge of it (Marsh &
Furlong, 2002, p. 18). That is, the researcher’s main objective is to investigate a societal phenomenon based on facts that are observable and can be quantifiable. In such a study, the researcher seeks to remain objective throughout the process and ensures to base his conclusions by observing the data used in the research activity (Marsh & Furlong, 2002, p. 22).
Subjectivism on the other hand, argues that the world is socially constructed. Using this ontological view, researchers seek to study the pattern of relationship and meanings that are created through social actions and interactions rather than social behavior per se (Long et al., 2000, p. 193). The researcher’s main objective is to try and understand a particular problem based on individual perceptions and experiences.
The aim of this research is to identify the pattern of Nordic firms’ payout policy in the 21-st century and to study the relationship of firm characteristics to payout policy. We intend to objectively analyze data and use it as a base for our conclusions based in the “real” world without social constructs' influence. Therefore, in this case an objectivist ontological approach is more appropriated for our study.
2.4. Epistemology
Epistemology is related to what is considered to be knowledge. It reflects on what the researcher can know about the world and how the researcher can understand a particular phenomenon (Marsh & Furlong, 2002, p. 20). Unlike the ontological position which influences how research questions are asked and answered, the epistemological position allows the researcher to further narrow the approach of knowledge acquisition by concentrating on one’s worldviews about issues within the philosophy of knowledge (Morgan, 2007, p. 52).
Epistemology is commonly divided in two main approaches: positivism and interpretivism (Saunders et al., 2016, p. 127). Positivism paradigm is concerned in studying the causal relationships of phenomena in order to give explanations and make predictions (Marsh &
Furlong, 2002, p. 20). In other words, positivists are mostly concerned with the relational effect of factors, determinants of variables, among other things. Unlike positivism, proponents of interpretivism rejects the view that the world exists independently of our knowledge (Marsh &
Furlong, 2002, p. 26). They argue that knowledge is subjective and because individuals' interpretation of facts can vary, it is quite hard to generalize regarding human behaviour (Saunders et al., 2016, p. 131). As mentioned before, the purpose of our research is to identify the pattern of Nordic firms’ payout policy in the 21-st century and to study the relationship of firm characteristics to payout policy. We will use historical data, hypothesis formulation and statistical tests. Accordingly, we will base our conclusion on facts that do not require subjective interpretation. To this end a positivist approach is more suitable for our study, and it will allow us to form conclusions free from social constructs.
8 2.5. Research Approach and Method
The selection of research approach is a very important aspect in academic writing. It helps the definition of research’s design and also holds direct implications to the study’s theory. The choice of a research approach will determine whether the research is theory-driven or data- driven (Morgan, 2007, p. 71). The two main approaches in academic research are inductive and deductive (Saunders et al., 2016, p.1 44).
The inductive approach is data-driven and runs from a particular observation to generalizations (Morgan, 2007, p. 71). It contains knowledge assertions not empirically implied by the premises, and the conclusion is more than an explanation of premises. Therefore, it is considered a way of amplifying knowledge (Ketokivi & Mantere, 2010, p. 316). In the inductive approach, data collection and analysis are the ground for the generation of a new theory that can explain the observed findings (Saunders et al., 2016, p. 145).
On the other hand, the deductive approach is theory-driven and departs from a group of general premises to specific logical conclusions, being the conclusions true when the premises are true (Ketokivi & Mantere, 2010, p. 316). The researcher explores available theories through hypothetical testing, which usually involves the use of statistical data to analyze or observe a phenomenon in relation to a given theory (Saunders et al., 2016, p. 145). One important attribute of deductive approach is generalisation. Therefore, the sample used by researchers must have sufficient size for the conclusions to be generalized (Saunders et al., 2016, p. 147).
Furthermore, a research approach should be accompanied by an appropriate research method.
The most well-known methods in academic research writing are qualitative and quantitative.
Quantitative studies often investigate the relationship between variables that are numerically measured and analyzed using a set of statistical techniques. It is usually correlated with positivism and a deductive approach (Saunders et al., 2016, p. 166). In contrast, qualitative methods are related to interpretive philosophy and authors need to consider subjective and social constructed meanings regarding the phenomenon studied. This type of research usually adopts an inductive approach and theory development (Saunders et al., 2016, p. 168).
The choice of methods is dependent on the phenomenon the author is investigating and whether the field of research being studied is new. Edmondson & McManus (2007, p. 1158) suggests that a research method should be determined by the level of recentness and maturity of the theory. The authors argue in favor of the use of qualitative methods in fields with nascent issues because it allows the research to use open-ended data to interpret and generate meanings. When the field under investigation achieves maturity, the use of quantitative methods is more relevant since it leads to theory refinement through the use of hypothesis tests (Edmondson &
McManus, 2007, p. 1162). Figure 1 presents the association between field maturity and research method defended by Edmondson & McManus (2007, p. 1168).
9 Figure 1. Methodological Fit. Source Edmondson & McManus (2007), p. 1168.
We claim that enough theories have been developed in the topic of payout policy to classify the field as mature. Accordingly, we will conduct a study using deductive approach and quantitative method. Based on the theories selected, we will deduct hypotheses which will guide our data collection. Our statistical analysis of data will allow us to confirm or reject the hypotheses and present conclusions.
2.6. Literature Search
The literature search is a time-consuming process and must be planned carefully in order to use time wisely when searching for literature (Saunders et al., 2016, p. 90), additionally the process allows you to learn from findings of previous studies. The author also argues that you should perform literature search with research questions and objectives in mind because it forces you to think about your research strategy (Saunders et al., 2016, p. 91).
If research regarding your research topic has been done for a considerable time, you are more likely to find abundant material for your study. Because payout police have been extensively explored, we find many relevant articles that supported our theoretical framework. However, due the high volume of material we did a careful analysis of previous literature, in order to guarantee we are addressing a research gap.
In our search we used mainly Business Source Premier and Emerald databases accessed from Umeå University’s library and Google Scholar. The initial investigations used terms such as:
“payout policy”, “dividends”, “dividends payment”, “share repurchases”, “signaling theory”,
“Miller and Modigliani”, “agency theory”, “dividend smoothing”,” flexibility hypothesis”.
Based on these terms we find many articles regarding payout policies which enable us to do a systematic literature review in order to identify contributions of previous research, analyse and summarize the findings (Saunders et al., 2016, p. 108). We also find relevant references when reviewing the studies initially identified. We decided to use only original sources, so when we chose to use a referred article, we downloaded the original text, in order to avoid the interpretation from another author.
10 2.7. Sources Criticism
In order to increase the credibility of our study we used reliable academic sources within payout policies. In this study we used peer reviewed articles from authorized scientific journals such as The Journal of Finance, Global Finance Journal and Journal of Financial Economics. As aforementioned, the articles have been collected from Business Source Premier, Emerald and Google Scholar, which are all well-known and reputable sources of literature that confer quality to the information applied in this research.
We tried to use up-to-date literature in order to check if the findings from previous research are still valid. However, we also decided to include some old articles that constitute the foundation of the theoretical framework and were the basis of the development of many recent studies. Some scholars could argue that the age of the articles could be an obstacle to compare results over time, however many of them contain the groundwork of theories that are still considered to be the most influential in payout policies, so we understand it is important to include it. We also include a few articles that focus specifically on Nordic countries. Since this study uses Nordic firms as our sample, we consider it is important to include research within Nordic countries in the body of literature. The data used in this study has been collected from Thomson Reuters DataStream Eikon database, which is a platform that gives users access to financial information regarding public traded companies worldwide. Thomson Reuters platform is a well-known database used for many academics and companies around the globe, which leads us to believe in the accuracy of the information disclosed in the platform. Some information provided by Thomson Reuters is extracted from the firm's financial statements, and others may argue that financial information produced by the company can be manipulated or distorted. However, since the Common Nordic Proposal for harmonization established in April 1969, Nordic countries have accomplished a high degree of accounting standards amornizations (Agami & Monsen, 1995, p. 201). This harmonization of standards and the fact that listed companies have to be audited by an independent firm, made us believe that the financial data is reliable.
Lastly, most of the reference studies used in this research cover data from countries that present different cultural, political and physical aspects when compared to the Nordic region. This means that the results from previous studies may not be directly applicable to our sample data.
However, we believe that the analysis of previous research was very important when building our theoretical framework and also served as a benchmark giving important inspiration for the conduction of this research.
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3. Chapter : Theoretical Framework
The third chapter provides the reader with the necessary theoretical background and presents the most relevant hypotheses and theories regarding payout policies, such as Dividend Irrelevance Theory, Signaling Theory, Agency Theory, Life-cycle Theory and Substitution and Flexibility Hypotheses. It also presents firm characteristics that will be analysed followed by hypotheses used in this study and an introduction to payout’s pattern.
3.1. Miller-Modigliani Dividend Irrelevance Theory
The relevance of dividends to a company’s value and shareholders preference for dividends instead of other forms of compensation has been one of the most debated topics in corporate finance. The main arguments regarding dividend policies are divided on two main antagonic lines of thinking: on one side are scholars who believe dividend policy is irrelevant to a firm's value. On the other side, are scholars who argue that dividend is in fact relevant to a firm’s value (Blau & Fuller, 2008, p. 134). The main theory regarding dividend irrelevance surged with Miller & Modigliani (1961) and even though it was presented almost 60 years ago, it is still considered one of the most relevant theories when studying dividend payouts.
The Dividend Irrelevance Theory by Miller & Modigliani (1961, p. 412) argues that under a perfect market, dividends payout is irrelevant to a firm’s value under the following assumptions:
(i) Perfect market - holds the view that no participant is large enough to affect market prices and all actors have equal and costless access to information. Also, there are no transaction costs or taxes, so the conditions are the same for all participants.
(ii) Rational behavior - holds the view that shareholders always prefer options that will increase their wealth and are indifferent about earning forms, be it cash dividends or capital gains.
(iii) Perfect certainty - holds the view that all market participants have the same information and full assurance for future returns of every security. Based on that, there is no need to distinguish between investments. They classify all types of financial instruments as stocks.
Based on the assumptions discussed, dividend payments become irrelevant for shareholders, so investors would have no preferences between capital gains or dividends. Moreover, the theory considered that if firms pay new dividends, they are able to raise new capital by issuing costless new shares and investors are able to construct homemade dividends (Miller &
Modigliani, 1961, p. 414). Therefore, shareholders would not be willing to pay a premium price for dividend paying stocks, accordingly, making dividends irrelevant. The author's main argument is that under perfect market conditions there are no “financial illusions'' and a firm’s value is determined only by “real” factors, so in this case the dividend policy would be irrelevant (Miller & Modigliani, 1961, p. 412).
3.2. Signaling Theory
The assumptions presented in the dividend irrelevance theory are very difficult to observe on real markets. Market imperfections such as asymmetric information costs and transaction costs
12 impose challenges to the theory proposed by Miller & Modigliani (1961). Therefore, other theories regarding payout policies tried to incorporate market imperfections when explaining the topic. For example, Lintner (1956) developed the Signaling Theory, which is based on the assumption that dividend payments affect firm value, and therefore firms use dividends to send signals to shareholders about future performance (Lintner, 1956, p. 100).
Lintner (1956) was responsible for developing the ground basis of the signaling theory regarding payout policies. He acknowledges that a firm’s share prices usually adjust in response to changes in dividend payments. The study demonstrates that managers are reluctant to make changes in firms' dividend ratios that would need to be reversed because they believe shareholders prefer a stable rate. Therefore, companies tend to smooth dividends over time, not making considerable increases in dividend levels that cannot be maintained in the near future (Lintner, 1956, p. 99). His findings also suggest that dividends are sticky, and firms that paid dividends before are more likely to keep doing it.
After Lintner many scholars have presented works relating to the signaling theory, indicating that dividends provide an “information content” and that companies use dividends as a way to send signals to the market. Bhattacharya (1979, p. 259) affirms that due to different tax effects on dividends and capital gains combined with asymmetry information between firm insiders and investors about profitability and cash flows, dividends are used as a signal of expected future cash flows. An increase in dividends can be seen as a signal of future cash flow and future performance (Bhattacharya, 1979, p. 263). Therefore, the market uses dividend announcements to form expectations based on current earnings. The signaling costs may be worth it for good news to the firm. By increasing dividend levels, firms send a signal to shareholders that managers expect good future prospects (Miller & Rock, 1985, p. 1037).
However, due to signaling costs, only high-quality companies are able to use dividend payments to send information regarding future performances to outsiders. Low-quality firms would not be able to send “false” information to the market because they cannot keep sustainable levels of dividend payments, and cuts on payouts could cause a decline in the shares price (Al-Malkawi et al. 2014, p. 160).
There is not a consensus about the observation of signaling theory assumptions in real markets and research presents diverse results. Puspitaningtyas (2019, p. 73), shows empirical support for the signaling theory within the Indonesian market. The author provides evidence that in Indonesia dividend announcements contain relevant information for investors' decision- making process. Al-Malkawi et al. (2014, p. 164) finds evidence that Omani firms use dividend payments to send signals to shareholders about their future cash flows. Another study conducted in the Nordic region covering Denmark, Norway and Sweden finds evidence that dividend payments reveal information about future earnings only in Sweden, so the results are not linear even between countries with high similarities (Liljeblom et al., 2015, p. 508).
Challenging the signaling hypothesis, DeAngelo et al. (1996, p. 369) finds no support for the assumption that dividend payments help distinguish firms with higher future earnings and Brav et al. (2005) performed a survey and show evidence that signaling is not among manager’s main concerns when deciding on payout policies.
Signaling theory does not provide much explanation for the increase in share repurchases. Even though repurchases can be seen as good news for shareholders it does not provide much content about a firm's future performance. In contrast to dividend payouts which have a tendency to grow smoothly, share repurchases do not imply a commitment to future payments, being more volatile and presenting substantial changes related to business cycles. That being said, in the
13 academic literature, share repurchases are more connected to financial flexibility (Jagannathan et al., 2000, p. 357) than signaling, which will be discussed in section 3.5.
3.3. Agency Theory
Agency theory adds to the signaling theory in the sense that it recognizes that information plays an important role in a firm's value. Furthermore, this theory recognizes that information asymmetry and different levels of information about a firm’s current and future performance can create conflict of interests among different parties. When firms’ hold a larger number of shareholders, they incur in additional costs to reduce the agency cost of equity. Informing shareholders about the market firm's evaluation can be more costly than sending information through the dividend process (Rozeff, 1982, p. 250). Therefore, firms tend to distribute cash to shareholders in order to reduce agency costs.
Agency theory is a fundamental theory when it comes to firms’ decisions regarding payout policies. One of the most important studies in the field was conducted by Jensen & Meckling (1976) and it has been used as a relevant reference in academia. The authors defined agency theory as a contractual relationship between agents referred to as a firm’s managers and principals also known as shareholders or a firm’s investors (Jensen & Meckling, 1976, p. 308).
The contractual relation empowers the agents (managers) to make decisions on behalf of the principals (shareholders) delegating some decision power to the agents. However, because individuals tend to maximize their own utility, agents do not always act in order to maximize firm value, which would be in the best interest of the principals. Consequently, shareholders need to offer managers incentives and create ways to monitor agents’ actions, which cause the firm to incur in agency costs (Jensen & Meckling, 1976, p. 308). Although the study presents clear definitions of agency theory and agency costs, it does not explore the impact of it on a firm’s payout policies. Further studies have tried to explain this relationship and some studies show evidence that dividends can reduce agency costs between shareholders and firms (Jensen, 1986; La Porta et al., 2000; Rozeff, 1982).
Rozeff (1982, p. 249) argues that payment of dividends can reduce agency problems by reducing the available conditional funds to agents, and according to Rapp et al. (2014, p. 293) managers can use dividends payouts to reduce conflicts of interest with their investors. La Porta (2000) conducted a study to understand the impact of agency costs in payout policies around the world. By using two different agency models of dividends, his study presented two main outcomes. First, the results indicate dividends are paid in order to distribute cash as a result of minority inventor’s pressure. Second it shows that dividends are used as a replacement of legal protection in highly unprotected environments because it enhances the firm's reputation of good treatment to investors (La Porta et al., 2000, p. 27).
Jensen (1986) conducted a study examining the impact of agency cost on a firm’s cash flows financing and payout policies. The findings indicate that a high level of free cash flow increases conflict of interest between the firm’s management and their shareholders (Jensen, 1986, p.
323). That is, the firm’s shareholders become skeptical of managers when they maintain high liquidity levels because managers could use available cash to attend their personal interests, invest in unprofitable projects or create empire buildings. In order to prevent those conflicts, firms should pay excess cash flow to shareholders. Also, the fact that cuts in dividends reflect negatively, share prices reiterate the existence of agency costs related to free cash flow (Jensen, 1986, p. 324).
14 In summary the agency cost theory, holds the notion that payout policy, through the distribution of cash to shareholders, can be used as a device to establish a firm's optimum monitoring/bonding package and serve to reduce agency costs (Jensen, 1986; Rozeff, 1982).
The agency theory assumptions are also included and connected to the life-cycle theory, which is another important payout theory explored in the next section.
3.4. Life-cycle Theory
As discussed in the previous section agency costs are part of the explanation for a firm’s decision in distributing cash to shareholders. However, other theories also considered additional factors, such as the firm's life stage, when explaining firm preferences for different payout policies. The life-cycle theory adds to the framework suggesting that payout decisions are related to the firm's life cycle. Firms in different stages have different opportunities and therefore they behave differently in order to maximize their benefits (DeAngelo et al, 2006, p.
227).
The life-cycle theory is used in some studies in order to explain why firms pay dividends (Fama
& French, 2001; Grullon et al., 2002) and most studies are based on firm trade-offs between retaining and distributing profit. The theory mixes components of agency theory proposed by Jensen (1986) and firm investment opportunities evolution presented by Fama & French (2001). The theory states that a firm’s investment opportunities change during a firm's life, and companies adjust their payout policy in order to meet current opportunities. Therefore, young firms tend to retain earnings because they possess better investment opportunities and limited resources to finance it. On the other hand, mature firms have higher profits and few attractive investment opportunities, so they are likely to distribute free cash flow to shareholders in order to reduce agency costs and mitigate the chance that cash would be wasted (DeAngelo et al., 2006; Denis & Osobov, 2008; Fama & French, 2001). Evidence shows a strong relationship between the decision to distribute cash as dividends and the earned contributed capital mix (DeAngelo et al., 2006, p. 227). The authors results indicate that for industrial dividend paying firms, the volume of dividends paid is higher among firms that retain an expressive percentage of earnings, which supports the Life-cycle theory.
3.5. Substitution and Flexibility Hypotheses
Most of the previous theories presented offer explanations for dividend payments, but do not explore share repurchases. The analysis of Substitution and Flexibility Hypotheses therefore shed light on the matter and present possible explanations on a firm’s choice to use alternative methods in distributing cash to shareholders (Grullon & Michaely, 2002; Iyer & Rao, 2017).
The increase in the number of shares repurchases during the 80’s created room for many studies that try to explain the changing in payout policies patterns and firms’ motivational preferences regarding a specific form to transfer cash to shareholders. One of the earliest studies that investigate share repurchases was conducted by Bagwell & Shoven (1989). They claim that firms use share repurchases to replace dividends in order to provide lower tax costs for shareholders, since capital gains incur lower taxes than dividends (Bagwell & Shoven, 1989, p. 135). However, subsequent studies presented mixed findings. DeAngelo et al. (2000, p. 344) argues that tax related factors are unlikely the main cause of share repurchases. It is worth mentioning that our study does not analyze the impact of taxes on payout policies in the Nordic, but we believe it is relevant to mention that it is still a controversial factor when explaining a firm’s choice in distributing cash to shareholders.
15 If we consider Miller & Modigliani irrelevance theory which states that payout policy does not affect a firm’s value and shareholders should not have preferences when receiving dividends or capital appreciation, dividends and share repurchases can be seen as perfect substitutes. This fact has been used to explain firm’s behavior regarding payouts, and the substitution hypothesis portrays that companies use share repurchases as a replacement to dividend payments (Grullon
& Michaely, 2002, p. 1651). However, studies regarding this hypothesis present conflicting evidences. Shoven (1987, p. 51) finds no indication that increases in repurchases lead to decreases in total dividends. Moreover DeAngelo et al. (2000, p. 352) find no sign of substitution responses when examining the relationship between reduction of special dividends and increase in share repurchases. In contrast, Grullon & Michaely (2002, p. 1651) show empirical evidence that the escalation in the number of share repurchases in the US has been financed with cash that would potentially be used for dividend increases. They also claimed that repurchase is the most popular way for companies that initiate cash payouts (Grullon &
Michaely, 2002, p. 1649), which is in line with Brav et al. (2005, p. 520), who indicates that numerous firms that pay dividends today would have considered not to pay dividends if they had the opportunity to choose again.
Another explanation used in academia regarding firms' choices between share repurchases and cash dividends is the flexibility hypothesis. Flexibility is defined by Iyer & Rao (2017, p. 288) as a company capacity to decide whether to distribute cash to investors or to reinvest it internally. A survey conducted by Brav et al. (2005, p. 497) shows evidence that managers prefer share repurchases flexibility over dividends rigor. When companies repurchase shares, there is no guarantee or commitment that they will continue to do so, and a change in repurchases does not affect share prices significantly (Rapp et al., 2014, p. 297). Many other scholars explored the flexibility hypothesis in relation to a firm’s share repurchases (Blau &
Fuller, 2008; Jagannathan et al., 2000). Iyer & Rao (2017, p. 288) argues that flexibility could be the main variable to explain why firms repurchase shares rather than pay dividends.
Therefore, a firm’s flexibility could affect how management defines payout policies and distributes cash, whether through cash dividends or through share repurchases.
3.6. Summary of Theoretical Framework
The following is a summary of our presented theories and hypotheses presented in academia that provide different understandings about payout policies.
● Miller and Modigliani’s Dividend Irrelevance Theory
○ Under a perfect capital market, payout policy is irrelevant, and shareholders have no preference for any form of compensation.
○ Only real factors affect a firm's value and there are no financial illusions.
○ Is possible to build homemade dividends and investors are not willing to pay a premium for stocks which pay dividends.
● Signaling Theory
○ There is an information asymmetry between shareholders and firm insiders.
○ Dividend payments have informational content and work as a signal of future expected cash flows because low quality firms cannot afford to imitate this behavior.
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● Agency Theory
○ Agency theory exists due to contractual relationships between agents (managers) and principals (shareholders).
○ Agency costs can be reduced if firms pay dividends to shareholders.
○ Agency costs increase as the free cash flow increases and therefore managers have to pay excess cash to shareholders.
● Life-cycle Theory
○ Based on the firm's trade-off between retaining and distributing profit.
○ Firms adjust their payout policy in order to meet current investment opportunities.
○ Young firms tend to retain earnings to finance good investment opportunities.
Contrary, mature firms have higher profits and few attractive investment opportunities, so they are likely to distribute free cash flow to shareholders in order to reduce agency costs.
● Substitution and Flexibility Hypotheses
○ Share repurchases are considered as a substitution to dividend payments.
○ Because share repurchases do not imply in future commitments of payout, they confer more financial flexibility. Managers prefer share repurchases flexibility than dividends rigidity.
○ Firms that are starting to distribute cash payouts tend to do it in the form of share repurchases.
3.7. Firms Selected Factors
In this section we will discuss the selected factors that will be used to determine the relationship with payout policies. The selection of these factors was based on relevant previous studies regarding payout policies patterns, substitution and flexibility hypotheses and determinants of payouts (table 1 provides an overview of the selected studies).
Miller and Modigliani Dividend Irrelevance theory asserts that dividend policy does not impact a company's value, so according to this theory view, there is no factor that would affect a firm’s decision regarding its payout strategy. Therefore, it is worth noting that all the selected factors are related to the theories discussed above which recognizes that payout policy matters and influences firm’ value. There are plenty of studies that investigated the determinants of dividend payout ratios (Brav et al., 2005; Denis & Osobov, 2008; Pieloch-Babiarz; 2017;
Rozeff, 1982), but not much attention was given to determinants of share repurchases. From our selected studies only Eije & Megginson (2008) investigate the impact of firm characteristics on the propensity to repurchase shares. Since our purpose is to describe payout policy in the Nordic market, we will investigate the relationship of the selected factors with both cash dividends and share repurchases. We believe it will be interesting to determine if the relationships found by Eije & Megginson (2008) holds among Nordic firms and if any new correlations can be present.
17 Table 1. Overview of selected studies.
Author Country Type of cash
distribution Positive relationship Negative relationship
Holder et al. (1998) US Cash dividends Size, free cash flow,
number of shareholders
Growth, degree of inside ownership,
Fama & French (2001) US Cash dividends Size, profitability Growth
DeAngelo et al. (2004) US Cash dividends Earnings Growth
Brav et al. (2005) US and Canada Cash dividends and
share repurchases Debt ratio, excess cash
Eije & Megginson (2008) Europe Cash dividends and share repurchases
Reporting frequency, cash holdings, size, age
Retained earnings, debt ratio, growth
Denis and Osobov (2008) US, UK, Canada, Germany,
France, and Japan. Cash dividends Size, profit, retained
earnings Growth
Bildik et al. (2015)
USA and 32 other countries, including Canada, Australia, Brazil, Denmark, Finland
Cash dividends Size, profitability Growth
Liljeblom et al. (2015) Denmark, Norway and Sweden Cash dividends Earnings Labhane & Mahakud (2016)
India Cash dividends Size, maturity,
profitability, liquidity
Growth, leverage, risk
Pieloch-Babiarz (2017) Poland Cash dividends and
share repurchases Liquidity, profit, age, size Debt ratio
Grullon & Michaely (2002) US Cash dividends and share repurchases Size
Rapp et al. (2014) US Cash dividends and
share repurchases Growth
Profitability, cash holding, reversibility of capitals
Floyd et al. (2015) US Cash dividends and
share repurchases
Brunzell et al. (2014) Denmark, Finland, Iceland,
Norway, and Sweden Cash dividends Size, profit
Jagannathan et al. (2000) US Cash dividends and
share repurchases
Size, operating cash flow (dividends), non- operating cash flow (repurchases)
Blau & Fuller (2008) US Cash dividends and
share repurchases Liquidity Debt-to-equity
3.7.1. Debt
Debt is one of the firms’ factors most investigated in our selected studies. It is considered to be the total liabilities of a company - including both short and long-term liabilities. When analysing a firm's debt level, two main ratios are used most frequently: debt-to-assets-ratio and debt-to-equity-ratio. The debt-to-asset ratio indicates the proportion of assets that are financed by debt whereas debt-to-equity reflects investors’ ability to support a firm’s debt.
The investigation of the relationship between a company’s debt level and payout policy is supported by the agency theory. Jensen (1986, p. 324) argues that debt can be an efficient
18 substitute of dividends because it lowers agency costs related to free cash flow by reducing managers' access to cash. Therefore, debt levels are considered one of the determinants of payout policy. Previous studies find evidence that debt ratios are negatively correlated to the propensity to pay cash dividends and repurchase of shares (Eije & Megginson, 2008; Labhane
& Mahakud, 2016; Pieloch-Babiarz, 2017). Moreover, results indicate that firms with lower debt-to-equity ratio present expressive lower dividend payments than firms with high debt ratios (Blau & Fuller, 2008, p. 135). Based on the approach of Eije & Megginson (2008), our study will also use debt-to-asset ratio to investigate its impact on payout policies in Nordic countries. This is so because the mentioned study covers cash dividends and share repurchases, being more related to our purpose.
As the aforementioned studies show, there appears to have a negative relationship between debt and payout ratio. For this reason, debt will be used as an independent variable in this study and we will test its effect on payout policy. Based on that we will test the following hypothesis to determine whether the relationship identified in previous literature holds within the Nordic market.
H1: Debt is negatively related to payout ratios.
3.7.2. Profit
Earnings and profitability are also well-known measures used in determining corporate payout policies. A great number of research has been done in assessing whether a company’s earnings, income, or profit has a major influence in corporate payout policy decisions. As discussed earlier, the life-cycle theory suggests that profitable and mature firms tend to have more excess of cash because they do not have many interesting investment opportunities. Therefore they prefer to distribute cash to shareholders in order to reduce agency costs related to free cash flow (DeAngelo et al., 2006, p. 250). Eije & Megginson (2008) find evidence that more profitable companies are more likely to pay dividends and repurchase shares and that in Europe repurchases are strongly more sensitive to earnings than dividend payments (Eije &
Megginson, 2008, p. 348). Many other studies assessed the correlation of profits with dividend payments (Bildik et al., 2015; Brunzell et al., 2014; Denis & Osobov, 2008; Fama & French, 2001; Labhane & Mahakud, 2016; Pieloch-Babiarz, 2017). All studies show evidence of positive correlation between profitability and cash distribution to shareholders; however, many different measures were used. Bildik et al. (2015), Fama & French (2001) and Labhane &
Mahakud (2016) used earnings before interest and taxes (EBIT) to the company’s book-value of assets. Denis and Osobov (2008) used the same approach but considered earnings after taxes.
Another method used in previous studies was return on assets (ROA) (Brunzell et al., 2014;
Pieloch-Babiarz, 2017) and Pieloch-Babiarz, (2017) additionally used return on equity (ROE).
One disadvantage with the use of ROE is that it is affected by the percentage of debt and equity used to finance the firm (Leach & Melicher, 2016 p. 173). The ratio EBIT to total assets also has one drawback when it comes to comparing different firms because it can vary a lot for different industries, however, it has the advantage of excluding the impact of taxes. Taxes and fiscal benefits can vary a lot among firms and countries, so using profit after taxes may influence results. Aware of the disadvantage of using EBIT to total assets, we opt to EBIT as a measure because it is a more relevant profit metric for our study, since we are not covering taxes.
