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Journal of Applied Finance & Banking, vol. 10, no. 2, 2020, 1-21 ISSN: 1792-6580 (print version), 1792-6599(online) Scientific Press International Limited Determinants of Corporate Dividend Policy under Hyperinflation and Dollarization by Firms in Zimbabwe S. Mbulawa1, N. F. Okurut2, M. M. Ntsosa3 and N. Sinha4. Abstract Studies examining dividend policy within a developing market in the context of hyperinflation and dollarization are scarce. This study investigates the possibility of non-linearity in the determinants of corporate dividend policy; assessed how dividend policy is affected by other financial decisions and tests the applicability of the Lintner model. Panel ordinary least squares (OLS) and generalized methods of moments (GMM) techniques were employed for Zimbabwe listed, 2000 to 2016. The Lintner model is applicable under hyperinflation only and it can be specified as a non-linear function. The study confirms the existence of non-linearity between dividend policy and selected explanatory variables using an extended Lintner model. Furthermore, financing and investment decisions are important in explaining dividend policy. Corporate dividend policy should be developed in view of the future growth prospects, ownership concentration and shifts in monetary policy by the central bank. The policy should be sensitive to prevailing market conditions. JEL classification numbers: G320, G350, G390. Keywords: Dividend Policy, Hyperinflation, Dollarization, Linter Model, Zimbabwe 1 2 3 4 Corresponding Author: Department of Accounting & Finance, Botho University. Professor, Department of Economics, University of Botswana. Graduate Studies Coordinator, Department of Economics, University of Botswana. Professor, Department of Economics, University of Botswana. Article Info: Received: April 19, 2019. Revised: October 7, 2019. Published online: March 1, 2020. 2 S. Mbulawa et. al. 1. Introduction The pioneering work by Modigliani and Miller (1961) affirms that firm value is insensitive to dividend policy. Dividends are a residual paid when a firm fails to profitably invest excess earnings. The transactions cost theory (Fama, 1974) shows that high costs of raising finance cause firms to reduce dividend payouts. This is consistent with the pecking order hypothesis (POH) which shows that excess funds are availed for investment opportunities and not for dividend payout (Myers and Majluf, 1984). However, markets are imperfect (Gordon, 1963, Lintner, 1962) as such dividends affect firm value. The agency costs theory argues that payment of dividends removes excess profits which may be used for non-productive purposes (Easterbrook, 1984, Jensen, 1986). The clientele theory (Allen at el, 2000, Seida, 2001) argues that dividend policy matters only when the supply and demand of high dividend paying stocks differ. On the other hand, the bird in hand theory argues that the fear of risk by investors make them to prefer current as opposed to future dividends. Investor uncertainty falls away as they receive dividends in the current period. As a result they discount cash flows using a lower rate giving rise to a high firm value (Gordon, 1963, Lintner, 1962). Zimbabwe experienced hyperinflation between 1997 and 2008 following the land reform that was done to compulsorily acquire land from the white minority and give it to the landless black majority (Mandizha, 2014, Kararach et al, 2010). In addition, the payment of gratuities to war veterans and finance the war in Democratic Republic of Congo was not supported by the international community. Consequently, the International Monetary Fund (IMF) and the World Bank (WB) withdrew their financial support. In response to this, the government printed money to finance recurrent expenditure which became inflationary. High inflation adversely affected firm operations. Firms (Njanike et al, 2009, Chiwandamira, 2009) survived on speculative profits, investing in stable currencies and stock piling, asking for shorter payback and the level of dividend payout fell due to low real profits. By end of 2008, the rate of inflation had reached 231 million percent. The global political agreement was signed at the end of 2008 following pressure exerted by poor performance of the economy. This gave rise to the formation of the government of national unity at the beginning of 2009. This was followed by introduction of a multi-currency regime composed of the United States Dollar, South African Rand and Botswana Pula which became legal tender and immediately inflation fell to single digits. The economy and exchange rates stabilized, speculative activities and opportunities for making arbitrage profits ceased (Kararach et al, 2010; Sikwila, 2013). However, the country still experienced liquidity problems due to the loss of the lender of the last resort function by the Reserve Bank of Zimbabwe (RBZ). Firms were still unstable which affects the level of dividends distributed to shareholders. Formulating a policy on corporate dividend decisions was still important for firm managers under dollarization period as well. The annual headline inflation has been below 5% during the greater part of 2018. It surged to 21% in October 2018 and to 42.1% in December 2018. Increased Determinants of Corporate Dividend Policy under Hyperinflation………… 3 speculative tendencies and ever rising foreign currency rates on the parallel market are fueling inflation (RBZ, 2019). Dollarization ended on 24th of June 2019 through statutory instrument 142 which banned the use of any other currency and recognizes only the Zimbabwe Dollar as legal tender. The currency is now composed of bond notes and coins and electronic money, referred to as Real Time Gross Settlement (RTGS) dollars. Once again, the RBZ has regained its lender of the last resort function. The economic picture is still gloomy due to high uncertainty (Dzirutwe, 2019). The country still suffers from policy inconsistences which affect corporate behavior. These developments require a detailed analysis which falls outside the scope of this study. Literature is not yet clear on how firms make decisions on whether pay or not to pay dividends in the unique Zimbabwean context. The dearth of studies focusing on dividend policy under these conditions limits our understanding. The understanding of main corporate dividend theories may change, the testing of which has not been done. Potential non-linearity in the determinants of dividend policy have not been discussed in this context. Findings lack consensus on the best measure of corporate dividend policy and they are also country specific. The explanatory power of variables and acceptable theoretical propositions are expected to change under the two periods. Previous studies (Mutenheri, 2003, Elly and Hellen, 2013, Mirbagherijam, 2014, Nor, 2012, Pesantes, 2005) focused on dollarization and hyperinflation without explaining the dynamics in dividend policy. Thus, policy options based on previous studies fail to guide firm managers faced by the Zimbabwean scenario. The analysis of dividend policy in this context brings new insights and widens the scope for policy making. In view of this, the main objectives of study are to: analyse dividend policy to enhance our understanding and applicability of dividend theories; determine the key determinants of dividend policy and bring out the perceived non-linearities between dividend policy and selected variables; examine the impact of other corporate financial decisions and identify the best measure of dividend policy. This study shows that the Lintner model is applicable under hyperinflation, it can be extended and specified as a non-linear function. Dividend policy is best captured using dividend per share (PR1). Results confirm the existence of non-linearity relationship between dividend policy and selected variables (inside ownership, firm size and earnings per share). Furthermore, financing and investment decisions were important in explaining dividend policy. The effect of explanatory variables was sensitive to the sample period, method of estimation and the measure of the dividend policy employed. The rest of the study is organized as follows: section two discusses the theoretical framework and provides evidence from previous studies, section three discusses the methodology and data, section four discusses the results and section five concludes and provides policy implications. 4 S. Mbulawa et. al. 2. Literature Review 2.1 Theoretical Framework According to Lintner (1956) firms have target payout ratios, Ri , applied to current profits after tax ( Pit ). Adjustment rates, C i , defining the actual change in dividends and remains stable for firms across time since investors prefer stable dividends. Lintner developed a partial adjustment model to capture changes in dividend levels between any two periods. The model was based on the premise that managers are concerned with stability of dividend payments and hence they monitor the actual changes in dividends ( Dit ) from one period to the next. This is shown as (2.1) Dit =  i + Ci [ Dit* − Di ,(t −1) ] +  it Where, Dit = Dit* − Di ,(t −1) and Dit* = Ri ( Pit ) (2.2) Dividends in the current and previous years are represented by Dit and Di ( t −1) respectively, D it* is the dividend that the firm targets to pay. The theoretical dividend model 2.1 can be written as Dit =  it +  Pit + Di ,( t −1) +  it (2.3) Where:  = Ci ( Ri ) and  = 1 − C i ,  it is the error term and  it is a constant which is normally positive to show the reluctance by managers to cut dividends. The pattern of dividends become a smoothed pattern of earnings and shows the time path of permanent earnings. The model has been tested before by establishing factors that explain C i , establishing the target payout ratio that firms aim to achieve, Ri , and the significance of Pit in explaining dividend policy. These three factors are important in explaining the partial adjustment model. Previous studies (King’wara, 2015, He et al, 2016) have employed dividend per share data to measure dividend policy for listed firms. According to Ahmad and Javid (2009) the model by Lintner can be extended by incorporating other variables that affect a firm’s dividend policy. Dividend policy interacts with financing and investment decisions, due to market imperfections. For example, Al-Najjar and Belghitar (2011) argued that dividends and investment decisions are negatively related. This is supported by Bildik et al, 2015 who opined that large firms pay dividends in the absence of credible growth opportunities. Furthermore, Lahiri and Chakraborty (2014) showed that dividend and investments decisions are made by firms at the same time. Determinants of Corporate Dividend Policy under Hyperinflation………… 5 2.2 Empirical Review Several studies have been done in developed and developing countries and also in the African context. They have identified various determinants of dividend policy. Their findings fail to provide direction on the determinants of dividend policy in our context. This validates the argument that policy making in developing economies may not entirely rely on studies done elsewhere. Past studies found mixed effects for determinants of dividend policy and results on the impact of each variable remain inconclusive. Furthermore, some studies have identified some variables that are not important in explaining dividend policy. Table 2.1(a) and (b) summarize the determinants of dividend policy from previous studies. 6 S. Mbulawa et. al. Table 2.1(a): Determinants of Dividend Policy Variable Previous Dividends Firm Growth (FG) Leverage (FLEV6) Inflation (INFLN) Inside ownership (OWN1) Significant Positive Effect Zameer et al, 2013, Ahmad and Javid, 2009, Alzomaia & Al-Khadhiri, 2013, Edmund, 2018, Mirbagherijam, 2014 Mutenheri, 2003, Hosain, 2016, Bushra and Mirza, 2015. Nguyen et al, 2013, Ahmad and Javid, 2009, Kania and Bacon, 2005, Arshad et al, 2013, Gill et al, 2010 Mirbagherijam, 2014, Basse, 2009 Zameer et al, 2013, Saez and Gutierrez, 2015 Al-Najjar and Firm Size Kilincarslan, 2018, (SIZE2) Uwuigbe, 2013, Arif & Akbar, 2013, Arshad et al, 2013, Pathan et al, 2016 Significant Negative Effect Arshad et al, 2013, Farinha, 2003, Gill et al, 2010, Kania and Bacon, 2005, King’wara, 2015, Bushra and Mirza, 2015 Insignificant Effect Nguyen et al, 2013; Zameer et al, 2013, Ahmad and Javid, 2009, Edmund, 2018, Farinha, 2003, Alzomaia & Al-Khadhiri, 2013, Gangil and Nathani, 2018. Al-Najjar and Zameer et al, 2013, Ahmad Kilincarslan, 2018, Ahmad and Javid, 2009, Farinha, and Javid, 2009, Hosain, 2003, Rizqia and 2016, Uwuigbe, 2013, Sumiati, 2013, Alzomaia Huda and Abdullah, 2013, & Al-Khadhiri, 2013 Edmund, 2018, King’wara, 2015, Edmund, 2018, Khan et al, Mambo, 2012, Elly and 2013 Hellen, 2013 Farinha, 2003, Rizqia Nguyen et al, 2013, Arshad and Sumiati, 2013, Kania et al, 2013, Hosain, 2016 and Bacon, 2005 King’wara, 2015, Farinha, Zameer et al, 2013, Huda 2003, Bushra and Mirza, and Abdullah, 2013, Rizqia 2015 and Sumiati, 2013, Hosain, 2016 Determinants of Corporate Dividend Policy under Hyperinflation………… 7 Table 2.1(b): Determinants of Dividend Policy Variable Money Supply (MSP) Earnings per Share (EPS) Taxation Paid (TP) Investment Decisions (INV1) Institutional Ownership (OWN5) Significant Positive Effect Pandey and Bhat, 2004 Ahmad and Javid, 2009, Alzomaia & Al-Khadhiri, 2013, Mirbagherijam, 2014, King’wara, 2015 Rehman and Takumi, 2012 Adediran and Alade, 2013 Farinha, 2003, Allen et al, 2000 and Bozec et al, 2010 Significant Negative Effect Akyildirim et al, 2013 Arif & Akbar, 2013, Morck and Yeung, 2005, Chuang et al, 2018 Al-Najjar and Belghitar, 2011 Insignificant Effect Mambo, 2012 Gul et al, 2012, ul Hassan et al, 2013, Khan et al, 2017 Kania and Bacon, 2005, Huda and Abdullah, 2013, Bushra and Mirza, 2015 3. Data and Methodology 3.1 Model Specification The Levin, Lin and Chu (LLC) and Im, Pesaran and Shin (IPS) were used to test for unit root. The best panel ordinary least squares (OLS) estimation method was selected by applying tests on redundant fixed effects and the Hausman (1978) test on random effects panel OLS. The panel OLS model was specified as: ′ 𝑦𝑖𝑡 = 𝛽0 + 𝛽𝑓 𝑓𝑖𝑟𝑚𝑖𝑡 + 𝛽𝑚 𝑚𝑎𝑐𝑟𝑜𝑡′ + 𝜀𝑖𝑡 (3.1) Where: yit measures dividend policy, explanatory variables are captured using two composite variables: firm and macro as discussed. 𝛽 is a vector of parameters to be estimated. The error term (  it ) captures individual specific or time invariant component ( ai ) and a remainder component ( v it ). Diagnostic tests (coefficient and residual diagnostics) were applied on the FE model. The dynamic model explained the impact of previous dividends on current levels as specified in the Lintner model. The study also employed the generalized method of moments (GMM) by Arellano and Bond (1991). The model used a lag to show the speed of adjustment towards the desired level of corporate dividend policy (Myers, 8 S. Mbulawa et. al. 1977). The dynamic model was specified as follows: 𝑦𝑖𝑡 = 𝛼0 + 𝛼𝑦𝑖(𝑡−1) + 𝛽𝑋𝑖𝑡′ + 𝜀𝑖𝑡 (3.2) ′ Where, 𝑦𝑖𝑡 is a measure of dividend decisions, 𝑋𝑖𝑡 is a vector of explanatory variables, 𝜀𝑖𝑡 = 𝜇𝑖 + 𝜆𝑡 + 𝜔𝑖𝑡 . All variables are defined in Table 3.1. 3.2 Description of Variables and Expected Signs Dividend policy (PR) was measured using 3 variables to check for robustness of results (Table 3.1). It was specified as a function of firm and macro variables as follows. 𝑃𝑅 = 𝑓(𝐹𝐺, 𝐿𝐸𝑉, 𝐼𝑁𝑉, 𝑀𝑆𝑃, 𝐼𝑁𝐹𝐿𝑁, 𝑇𝑃, 𝑆𝐼𝑍𝐸, 𝐸𝑃𝑆, 𝑂𝑊𝑁) (3.3) Highly levered firms (LEV) pay less dividends due to high debt service costs (AlNajjar and Kilincarslan, 2018, Edmund, 2018). More dividends are paid where a firm relies on other sources of cash flows (Arshad et al, 2013, Nguyen et al, 2013). Payment of dividends may differ according to debt composition. High investment expenditure (INV) reduces the likelihood of paying dividends (Al-Najjar and Belghitar, 2011). Firms with more investment opportunities may source external funding where access to financial markets is easy and they can still maintain dividend payouts (Adediran and Alade, 2013). High earnings per share (EPS) guarantee payment of more dividends (Mirbagherijam, 2014, King’wara, 2015). Again, firms may not necessarily make huge dividend disbursements as they seek to retain funds for future use. More dividends are paid where managers seek to reward themselves using free cash flows (Zameer et al, 2013, Saez and Gutierrez, 2015). On the other hand, managerial ownership (OWN) may mean that managers would postpone the payment of dividends and invest to increase the firm’s future income generating capacity (Farinha, 2003, Rizqia and Sumiati, 2013). Institutional ownership (OWN5) provides an effective monitoring device for firms to help reduce overinvestment by firm managers. It reduces payment of dividends (Huda and Abdullah, 2013, Bushra and Mirza, 2015). On the other hand, firms with a good capital base may still pay dividends to institutional investors as they may not need to retain additional funds (Farinha, 2003, Allen et al, 2000 and Bozec et al, 2010). Taxation (TP) reduces funds available for payment of dividends (Arif & Akbar, 2013, Morck and Yeung, 2005, Chuang et al, 2018). Taxation may have a positive relationship with dividend payout where firm managers have chosen a certain dividend policy, desire to use dividends as a way to retain investors or have access to other financing alternatives (Rehman and Takumi, 2012). Large sized firms (SIZE2) pay more dividends as they are likely to be financially stable (Al-Najjar and Kilincarslan, 2018, Uwuigbe, 2013, Arif & Akbar, 2013). These firms could have taken more debt to finance their current levels of growth. This would reduce payment of dividends as they service past debts (King’wara, 2015, Bushra and Mirza, 2015). Inflation (INFN) and money supply (MSP) were useful in controlling Determinants of Corporate Dividend Policy under Hyperinflation………… 9 for hyperinflation and dollarization respectively as firms designed their dividend policy (Mirbagherijam, 2014Akyildirim et al, 2013). Firms are expected to have reduced dividends payout under hyperinflation and more payouts during dollarization period. Table 3.1: Variables Definitions and expected signs Variable Dividend Decisions (PR1) Dividend Decisions (PR2) Dividend yield (DYD) Firm growth (FG) Leverage (Flev 6) Investment decisions (INV1) Inflation (INFLN) Insider Ownership (OWN1) Institutional Ownership (OWN5) Firm size (SIZE2) Money Supply (MSP) Earnings per Share (EPS) Taxation (TP) Definition Expected signs Dividend paid/Total Shares Dependent variable Dividend Paid/Net Income Dependent variable Dividend Per Share/Market price per Dependent variable share % Change in total sales ((Current year +/Sales-Previous year Sales)/Previous Year Sales) Total debt/equity +/Net Fixed Assets (Total Fixed Assets+/Total Liabilities-Depreciation)/Total Assets Annual Inflation Rate divided by 100 +/Management shareholding/Total shares +/Total shares owned by Institutional +/Investors/Total Shares Log of Total Assets +/M2 over GDP, as a decimal +/Total Earnings over total shares + outstanding Taxation paid/Operating income +/- 3.3 Sources of Panel Data and Sample Size The study covered a 17-year period as follows: period of inflation (2000 – 2008) and dollarization (2009-2016). The choice of this period is detected by political and economic factors in Zimbabwe. Data was obtained from financial statements on company websites and the African Financials website. Data on macro-economic variables was obtained from World Bank (2017) and RBZ reports. There were 63 firms listed on the ZSE as at 31 December 2018. The study excludes three (3) companies under suspension, six (6) banking institutions and six (6) insurance firms. There was a total of eighteen (18) firms with incomplete data sets and some of them were registered after the year 2000. This leaves a total of thirty (30) firms giving a total of 510 firm years. Comparatively, Kowerski and Wypych (2016) employed 71 firms with 307 firm years. 10 S. Mbulawa et. al. 4. Results and Discussion 4.1 Descriptive Statistics and Diagnostic Tests The problem of multicollinearity was checked using Pearson correlation matrix. Correlation coefficients were mostly less than 0.5 which implies that there was no serious problem of multicollinearity between any pair of variables. Thus, all the variables could be used in the same model without giving spurious results (Table withheld). Findings further showed that fixed effects are not redundant for all the three sample periods. Random effects were correlated with explanatory variables. This implies that the FE model would be useful in the analysis. Furthermore, the study conducted unit tests at 5% level of significance. Results showed that all variables were stationary at levels (Table 4.1). Table 4.1: Unit Root Tests Levels 1st difference Levin, Lin & Chu Im, Pesaran & Shin Levin, Lin & Chu Im, Pesaran & Shin Variable Statistic Statistic Statistic Statistic FLEV6 -3.95*** -5.33*** -14.00*** -14.68*** INV1 -3.66*** -4.31*** -6.67*** -11.69*** PR1 -7.35*** -6.70*** -13.64*** -13.39*** PR2 -8.16*** -7.01*** -14.56*** -14.33*** DYD -6.71*** -6.34*** -11.56*** -12.14*** INFLN -11.60*** -6.72*** -18.59*** -13.63*** OWN1 -1.57* -1.71** -9.31*** -10.12*** OWN5 -5.51*** -3.65*** -8.25*** -9.38*** SIZE2 -3.86*** -3.02*** -13.86*** -13.59*** MSP -16.02*** -11.64*** -62.39*** -47.75*** EPS -6.93*** -4.59*** -16.62*** -14.77*** TP -5.82*** -5.89*** -13.88*** -14.89*** FG -12.00*** -11.67*** -16.19*** -18.89*** *** significant at 1%; ** significant at 5%; *significant at 10% 4.2 Evidence on the Determinants of Dividend Policy Firstly, the study tested the predictive power of the Lintner model. More variables were incorporated and estimations were done using GMM and FE models. Squared variables for ownership structure (Morck et al 1988, McConnel and Servaes, 1990), earnings per share and firm size were used to test for non-linearity in the model.