A Final Project Report

on

‘‘STOCK MARKET REACTION TO DIVIDEND

ANNOUNCEMENT’’

Submitted to

PUNJAB TECHNICAL UNIVERSITY

JALANDHAR

In the partial fulfillment of the requirement for the

award of degree of

Master of Business Administration (MBA)

Submitted by Project Guide

Shaina Swara Ms Neha Kalra

1172467 Assistant Professor

SESSION (2011-2013)

APEEJAY INSTITUTE OF MANAGEMENT TECHNICAL CAMPUS

JALANDHAR

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PREFACE

As MBA course requires equal attention towards practical as well as theoretical aspects

of business, various problems are to be dealt with in that course. That’s why research

programs are there to give deep as well as thorough knowledge of subjects and problems

that are practical whenever one entered in the profession. A research project constitutes

the backbone of any management education program. A management student has to quite

frequently do the research work during his entire span. Research programs are included in

the curriculum of various management courses so as to provide students with practical

knowledge and exposure to professional life.

My project entitled ‘Stock Market Reaction To Dividend Announcement’. A sincere

effort has been made to bring about clear facts and I hope that this report meets the given

expectations and various requirements of the research. I am highly gratified that I have

done this project and I am highly obliged to those respected persons who chosen us for

this work. And I duly ensure this work as an original work of mine and not a copy work.

The most motivating aspect associated with pursuing a course in management or business

studies is the dynamism associated with it. Dynamism of adding a new perspective to

one’s personality and vision by accumulating wider knowledge, developing analytical

skills not only by traditional ways of teaching and learning but by observing ‘things at

work’. The project is an opportunity to see the application part of what we study or learn

in classrooms. Management is that function of an enterprise that concerns itself with the

direction and control of the various activities to attain business objectives. It is the

science and art of preparing, organizing and directing human efforts to control the force

and utilize the materials of nature for the benefit of men. As a matter of fact, the

management thereby provides the scientific technique to deal with the various problems

in the areas of management and the manager mixes some art to it and tries to shorten the

gap of ignorance. It provides a chain of solution to critical problems of manager.

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ACKNOWLEDGEMENT

Nothing concrete can be achieved without an optimal combination of inspiration and

perspirations. I owe a sense of gratitude to the intelligence and co-operation of those

people who had been so easy to let me understand what i need from time to time for

completion of this exclusive project. I am greatly indebted to Mr. Rajesh Bagga

(Director), Ms. Neha Kalra and Ms. Nitika Sehgal (Assistant Professor) for their

advice and help which enabled me to finish this project report properly in time. I am also

thankful to all the respondents whose valuable information helped me considerably in the

successful completion of the study. I have furthermore to thank my friends for all their

help, support, interest, valuable hints and much needed motivation. Last but not the least,

I am very grateful to all those who had helped me in one way or the other at every stage

of my work.

Date: Shaina Swara

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CERTIFICATE

This is to certify that the project report entitled “Stock Market Reaction to Dividend

Announcement” submitted by Shaina Swara is a bonafide piece of work conducted

under my direct supervision and guidance. No part of this work has been submitted for

any other degree of any other university. The data sources have been duly acknowledged.

It may be considered for evaluation in partial fulfillment of the requirement for the award

of degree of Master of Business Administration.

Date: Ms. Neha Kalra

Asst Professor

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TABLE OF CONTENTS

Preface

Acknowledgment

Certificate

2

3

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CHAPTER NO. CHAPTER TITLE PAGE NO.

1. Introduction 6-34

2. Review of Literature 35-38

3. Need, Scope & Objectives of the Study 39-41

4. Research Methodology 42-46

5. Data Analysis & Interpretation 47-50

6. Findings of the Study 51-52

7. Conclusion 53-54

References 55-56

Annexure

A. Questionnaire

57-61

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Chapter 1INTRODUCTION

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1. The Indian Stock Market

In India, there are 19 recognised stock exchanges. However, as per the legal structure,

these stock exchanges are divided into two main groups. One group consist of 16 stock

exchanges namely Madras Stock Exchange, Cochin Stock Exchange, Bhubaneswar Stock

Exchange, OTCEI, Inter-connected Stock Exchange, Guwahati Stock Exchange,

Bangalore Stock Exchange, Vadodara Stock Exchange, Delhi Stock Exchange, Calcutta

Stock Exchange, Pune Stock Exchange, Jaipur Stock Exchange, Uttar Pradesh Stock

Exchange, Ludhiana Stock Exchange, National Stock Exchange (NSE), Coimbatore stock

exchange that were started by companies which were limited by shares or by guarantees.

The second group consist of 3 stock exchanges namely Bombay Stock Exchange (BSE),

Madhya Pradesh Stock Exchange and Ahmedabad Stock Exchange which earlier were

established as an association of persons and then transformed into companies later.

In India, all the stock exchanges are supervised and regulated by the Securities and

Exchange Board of India (SEBI), a regulatory authority. SEBI was set up in April, 1992

as a regulatory authority to protect investor's interest and to regulate and develop the

securities market in India. As per SEBI's regulations all the stock exchanges needed to

complete the process of demutualisation and corporatisation. However, except for

Coimbatore stock exchange the remaining 18 stock exchanges are operating as profit

companies limited by shares which have been demutualised and corporatized.

Although there are 19 stock exchanges, the BSE and NSE are the two main and important

stock exchanges functioning in India. For the study undertaken in this paper, firms listed

in BSE 100 are taken into consideration.

In Asia, BSE is the oldest stock exchange by being in existence for 133 years starting in

1875.However, in 1956 as per the Securities Contracts (Regulation) Act (1956), BSE

received a permanent recognition making it to become the first stock exchange to get

such recognition in the country by the Government of India. As of today, among

exchanges it ranks at the first position for the number of companies listed and for number

of transactions it ranks at the fifth position. As on 31st December 2007, BSE had a

market capitalization of about USD 1.79 trillion. BSE has aided in the growth of the

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corporate sector in India by enabling the firms to take to their advantage and efficiently

benefit from the various resources offered by the BSE. Majority of the companies have

raised resources using the services of BSE from the capital market. The Bombay Stock

Exchange provides 21 indices out of which 12 are sectoral indices.

BSE 100 is one of the indices offered by the Bombay Stock Exchange. It was launched

on 3rd January 1989 as was earlier called BSE National Index.BSE 100 consist of 100

scrips i.e. companies from various industry sectors and trading on different exchanges.

The BSE 100 index covers movement of share prices of companies on national level.

Since 2004 it has adopted the free float methodology for computation. This is a method to

construct an index which is based on the concept of free float where the shares that are

readily available for trade in the market in the normal course. It excludes the shares that

are held by any strategic investors, government holdings and the promoter holdings. Such

a way of calculation thus reduces the market capitalisation of a company to only the

number of shares that could be traded in the market every day. This helps to trace the

current trends in the market easily. It does not allow only a few companies with large

market capitalisations to dominate the index thus making the index a very broad based

one. Free float index is beneficial for investors having both active and passive style of

investment. An active investor can compare his or her realised returns to a benchmark

which is a closer representation of an investible index. In case of a passive investor it

reduces the tracking error. Free float mechanism has been notably adopted by various

developed market index providers like MSCI, FTSE, S&P and STOXX. In this regard,

firms listed on BSE 100 made an ideal choice to be the sample for this study.

1.1 INTRODUCTION ABOUT BOMBAY STOCK EXCHANGE (BSE)

Established in 1875, BSE Ltd. (formerly known as Bombay Stock Exchange Ltd.), is

Asia’s first Stock Exchange and one of India’s leading exchange groups. Over the past

137 years, BSE has facilitated the growth of the Indian corporate sector by providing it an

efficient capital-raising platform. Popularly known as BSE, the bourse was established as

"The Native Share & Stock Brokers'Association"in1875. 

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BSE is a corporatized and demutualised entity, with a broad shareholder-base which

includes two leading global exchanges, Deutsche Bourse and Singapore Exchange as

strategic partners. BSE provides an efficient and transparent market for trading in equity,

debt instruments, derivatives, mutual funds. It also has a platform for trading in equities

of small-and-medium enterprises (SME). Around 5000 companies are listed on BSE

making it world's No. 1 exchange in terms of listed members. The companies listed on

BSE Ltd command a total market capitalization of USD Trillion 1.06 as of May 15, 2012.

BSE Ltd is world's fifth most active exchange in terms of number of transactions handled

through its electronic trading system. It is also one of the world’s leading exchanges (5th

largest in May 2012) for Index options trading

BSE also provides a host of other services to capital market participants including risk

management, clearing, settlement, market data services and education. It has a global

reach with customers around the world and a nation-wide presence. BSE systems and

processes are designed to safeguard market integrity, drive the growth of the Indian

capital market and stimulate innovation and competition across all market segments. BSE

is the first exchange in India and second in the world to obtain an ISO 9001:2000

certification. It is also the first Exchange in the country and second in the world to

receive Information Security Management System Standard BS 7799-2-2002 certification

for its On-Line trading System (BOLT). 

It operates one of the most respected capital market educational institutes in the country

(the BSE Institute Ltd.). BSE also provides depository services through its Central

DepositoryServicesLtd.(CDSL)arm. 

BSE’s popular equity index SENSEX - is India's most widely tracks stock

market benchmark index. It is traded internationally on the EUREX as well as leading

exchanges of the BRCS nations (Brazil, Russia, China and South Africa). 

Vision

Emerge as the premier Indian stock exchange with best-in-class global practice in

technology, products innovation and customer service.

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Heritage

BSE Ltd, the first ever stock exchange in Asia established in 1875 and the first in the

country to be granted permanent recognition under the Securities Contract Regulation

Act, 1956, has had an interestingrisetoprominenceoverthepast137years. 

While BSE Ltd is now synonymous with Dalal Street, it was not always so. The first

venue of the earliest stock broker meetings in the 1850s was in rather natural environs -

under banyan trees - in front of the Town Hall, where Horniman Circle is now situated. A

decade later, the brokers moved their venue to another set of foliage, this time under

banyan trees at the junction of Meadows Street and what is now called Mahatma Gandhi

Road. As the number of brokers increased, they had to shift from place to place, but they

always overflowed to the streets. At last, in 1874, the brokers found a permanent place,

and one that they could, quite literally, call their

own.Thenewplacewas,aptly,calledDalalStreet(Brokers'Street). 

The journey of BSE Ltd. is as eventful and interesting as the history of India's securities

market. In fact, as India's biggest bourse in terms of listed companies and market

capitalisation, almost every leading corporate in India has sourced BSE Ltd. services in

raising capital and is listed withBSELtd. 

Even in terms of an orderly growth, much before the actual legislations were enacted,

BSE Ltd. had formulated a comprehensive set of Rules and Regulations for the securities

market. It had also laid down best practices which were adopted subsequently by 23 stock

exchanges which weresetupafterIndiagaineditsindependence. 

BSE Ltd., as a institutional brand, has been and is synonymous with the capital market in

India. Its SENSEX is the benchmark equity index that reflects the health of the Indian

economy. 

BRAND IDENTITY

Bombay Stock Exchange has now adopted only its initials as the new name (BSE),

positioning itself better position as a national multi-asset financial infrastructure

institution. BSE’s strategic shift in approach, attitude and business focus is reflected in its

newtagline- ExperiencetheNew. 

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With renewed zeal and focus on new business opportunities, product and service

innovation, upgrades in technology, increased investor and member focus, BSE is always

pushing the envelope on all fronts. The ambition is to continually improve and adopt new

and better ways of conduction of business. 

As the first stock exchange in Asia and the pioneer of securities transaction business,

BSE prides itself on being at the forefront of bringing innovations to the Indian capital

markets while creating diverse investment opportunities for the investor community in

India throughout its long history. 

BSE continues to undertake several initiatives to build on its strong brand, legacy and

market position to create value for its stakeholders and the financial system. 

ACHIEVEMENTS

At par with international standards, BSE Ltd. has been a pioneer in several areas over the

decades and has many firsts and key achievements to its credit. BSE is the first exchange

in India to 

Launch a special platform for trading in SME securities

Introduce Equity Derivatives

Launch a Free Float Index - SENSEX

Launch Exchange Enabled Internet Trading Platform

Obtain ISO certification for a stock exchange

Exclusive facility for financial training – BSE Institute Ltd.

Launch its website in Hindi and regional languages

Host the popular opening-bell ceremony in Indian capital markets

Launch mobile-based trading in India in Sept 2010

Become securities market infrastructure member of SWIFT in India and provide

corporate actions to custodians in ISO 15022 format

Launched SENSEX Realized Volatility (REALVOL) Index in Nov 2010

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Besides the above, BSE has taken large strides in product and service innovation for the

benefit of its members and investors, notable ones being 

Launch of a reporting platform for corporate bonds

Launch of the BSE IPO index and PSU website

Revamp of its website with wide range of new investor-friendly features

Launch of trading in SENSEX futures on EUREX and leading exchanges of the

BRICS nation bloc

Launched Smart Order Routing for members and investors

Introduced SACT (SMS alert & Complaint Tracking system)

Launched co-location facility at BSE premises in November 2010

Reduction in membership fees to Rs. 10 lakh for new memberships to promote

financial access and inclusion

Launch of web-based mutual fund trading platform for investors

AWARDS AND RECOGNITION

As a pioneering financial institution in the Indian capital market, BSE has won several

awards and recognitions that acknowledge the work done and progress made. 

The Golden Peacock Global CSR Award for its initiatives in Corporate Social

Responsibility

BSE has won NASSCOM - CNBC-TV18’s IT User Awards, 2010 in Financial

Services category

BSE has won Skoch Virtual Corporation 2010 Award in the BSE StAR MF

category

Responsibility Award (CSR), by the World Council of Corporate Governance

Annual Reports and Accounts of BSE have been awarded the ICAI awards for

excellence in financial reporting for four consecutive years from 2006 onwards

Human Resource Management at BSE has won the Asia - Pacific HRM awards

for its efforts in employer branding through talent management at work, health

management at work and excellence in HR through technology.

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CSR (Corporate Social Responsibility)

Corporate Social Responsibility (CSR) in BSE is aligned with its tradition of creating

wealth in the community with a three pronged focus on Education, Health and the

Environment. Besides funding charitable causes for the elderly and the physically

challenged, BSE has been supporting the rehabilitation and restoration efforts in

earthquake-hit communities of Gujarat. BSE has been awarded the Golden Peacock

Global - CSR Award for its initiatives in Corporate Social Responsibility (CSR) by the

World Council of Corporate Governance. 

Overview Of The Corporate Sector

As compared to corporate governance in developed countries, Indian corporate

governance is quite different. In India, the corporate sector is not homogenous but

contains a mixture of companies from government and private sector. The private sector

again is a mixed bag of firms where the ownership ranges from multinationals to family

business or individually owned firms. Various activities of corporate like share holders'

rights, company's administration and governance, dividend announcements and various

other disclosures etc take place under the legal framework of the Companies Act

(1956).This legal framework has been fairly stable over the years.

As observed in various other emerging markets, the structure of ownership of corporate

firms in India is also categorized by large shareholders. Generally the largest

shareholders are given incentives and also the right to manage key decisions (e.g.

dividend payout).In India also, the discretion of how much dividend to announce or

whether not to announce any dividend only is solely dependent of the company's

directors.

The Companies Act (1956), section 205 has set up certain rules and guidelines for all

corporate firms which announce or pay dividend during any financial year. Under the

section 205 (2),dividends announced or paid by firms must be out of its profits for that

year or previous year after taking depreciation into consideration for that year or previous

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year respectively or could be out of both the profits. Another option under section 205

allows companies to pay or announce dividends from the money which the Central or a

State government provides towards the dividend payment in order to fulfil any guarantee

which the Government has given. Under section 205 (A),any company declaring

dividend should deposit the dividend amount within 5 days from the dividend declaration

date in a separate bank account and within 30 days form dividend announcement date

should pay the dividend declared.

Generally in India, companies announce and pay dividends two times in a year which is

known in form an interim and a final dividend. As seen companies pay dividend out of its

profits and is like giving shareholders part of its earnings. Hence for shareholders

dividends act as a source of income. In India, to actually understand amount a company

pays out of its profits and the amount it retains to plough back for enhancing the business,

dividends announced are generally conveyed on basis of ‘per share' like for example Rs 4

per share. To better understand the above mentioned sentence let's take an example. For

instance, a company has Rs 8 earnings per share in the year and declares and pays Rs 4

dividend per share which implies that the company is distributing to its shareholders half

of its profits and retaining other half to plough back into the business. This acts as a

signal to the shareholders that the company is prospering leading to further investments

and leading to increase in share price when a company announces to pay dividends.

Hence in case the company declares a decrease in dividend per share, the market reacts

looking at the stock as a growth opportunity for their investment since the company is

now investing an increased surplus of funds in much more profitable ventures. Therefore

in India, amount a company declares as dividend on per share basis is very crucial as

investors judge the future prospects of the company on the amount it retains for

reinvestment into profitable business activities based on the dividend per share declared.

1.2 DIVIDEND

Dividends are payments made by a corporation to its shareholder members. It is the

portion of corporate profits paid out to stockholders. When a corporation earns a profit or

surplus, that money can be put to two uses: it can either be re-invested in the business

14

(called retained earnings), or it can be distributed to shareholders. There are two ways to

distribute cash to shareholders: share repurchases or dividends. Many corporations retain

a portion of their earnings and pay the remainder as a dividend.

A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a

dividend in proportion to their shareholding. For the joint stock company, paying

dividends is not an expense; rather, it is the division of after tax profits among

shareholders. Retained earnings (profits that have not been distributed as dividends) are

shown in the shareholder equity section in the company's balance sheet - the same as its

issued share capital. Public companies usually pay dividends on a fixed schedule, but

may declare a dividend at any time, sometimes called a special dividend to distinguish it

from the fixed schedule dividends.

Cooperatives, on the other hand, allocate dividends according to members' activity, so

their dividends are often considered to be a pre-tax expense.

Dividends are usually paid in the form of cash, store credits (common among retail

consumers' cooperatives) and shares in the company (either newly created shares or

existing shares bought in the market.) Further, many public companies offer dividend

reinvestment plans, which automatically use the cash dividend to purchase additional

shares for the shareholder.

The word "dividend" comes from the Latin word "dividendum" ("thing to be divided")

Joint stock company dividends

A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a

dividend in proportion to their shareholding.

Forms of payment

Cash dividends (most common) are those paid out in currency, usually via electronic

funds transfer or a printed paper check. Such dividends are a form of investment income

and are usually taxable to the recipient in the year they are paid. This is the most common

15

method of sharing corporate profits with the shareholders of the company. For each share

owned, a declared amount of money is distributed. Thus, if a person owns 100 shares and

the cash dividend is USD $0.50 per share, the holder of the stock will be paid USD $50.

Dividends paid are not classified as an expense, but rather a deduction of retained

earnings. Dividends paid does not show up on a Income Statement but does appear on the

Balance Sheet.

Stock or scrip dividends are those paid out in the form of additional stock shares of the

issuing corporation, or another corporation (such as its subsidiary corporation). They are

usually issued in proportion to shares owned (for example, for every 100 shares of stock

owned, a 5% stock dividend will yield 5 extra shares). If the payment involves the issue

of new shares, it is similar to a stock split in that it increases the total number of shares

while lowering the price of each share without changing the market capitalization, or total

value, of the shares held.

Property dividends or dividends in specie (Latin for "in kind") are those paid out in the

form of assets from the issuing corporation or another corporation, such as a subsidiary

corporation. They are relatively rare and most frequently are securities of other

companies owned by the issuer, however they can take other forms, such as products and

services.

Interim dividends are dividend payments made before a company's annual general

meeting (AGM) and final financial statements. This declared dividend usually

accompanies the company's interim financial statements.

Other dividends can be used in structured finance. Financial assets with a known market

value can be distributed as dividends; warrants are sometimes distributed in this way. For

large companies with subsidiaries, dividends can take the form of shares in a subsidiary

company. A common technique for "spinning off" a company from its parent is to

distribute shares in the new company to the old company's shareholders. The new shares

can then be traded independently.

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Reliability of dividends

There are two metrics which are commonly used to gauge the sustainability of a firm's

dividend policy.

Payout ratio is calculated by dividing the company's dividend by the earnings per share.

A payout ratio greater than 1 means the company is paying out more in dividends for the

year than it earned.

Dividend cover is calculated by dividing the company's cash flow from operations by the

dividend. This ratio is apparently popular with analysts of income trusts in Canada.

Dividend dates

Any dividend that is declared must be approved by a company's Board of Directors

before it is paid. For public companies, there are four important dates to remember

regarding dividends. These are discussed in detail with examples at the Securities and

Exchange Commission site

Declaration date is the day the Board of Directors announces its intention to pay a

dividend. On this day, a liability is created and the company records that liability on its

books; it now owes the money to the stockholders. On the declaration date, the Board

will also announce a date of record and a payment date.

In-dividend date is the last day, which is one trading day before the ex-dividend date,

where the stock is said to be cum dividend ('with [including] dividend'). In other words,

existing holders of the stock and anyone who buys it on this day will receive the

dividend, whereas any holders selling the stock lose their right to the dividend. After this

date the stock becomes ex dividend.

Ex-dividend date (typically 2 trading days before the record date for U.S. securities) is

the day on which all shares bought and sold no longer come attached with the right to be

paid the most recently declared dividend. This is an important date for any company that

has many stockholders, including those that trade on exchanges, as it makes

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reconciliation of who is to be paid the dividend easier. Existing holders of the stock will

receive the dividend even if they now sell the stock, whereas anyone who now buys the

stock will not receive the dividend. It is relatively common for a stock's price to decrease

on the ex-dividend date by an amount roughly equal to the dividend paid. This reflects

the decrease in the company's assets resulting from the declaration of the dividend. The

company does not take any explicit action to adjust its stock price; in an efficient market,

buyers and sellers will automatically price this in.

Book closure Date Whenever a company announces a dividend pay-out, it also

announces a date on which the company will ideally temporarily close its books for fresh

transfers of stock.

Record date Shareholders registered in the stockholders of record on or before the date

of record will receive the dividend. Shareholders who are not registered as of this date

will not receive the dividend. Registration in most countries is essentially automatic for

shares purchased before the ex-dividend date.

Payment date is the day when the dividend cheques will actually be mailed to the

shareholders of a company or credited to brokerage accounts.

Effect on stock price

After a stock goes ex-dividend (e.g. the financial obligation for the company to pay the

dividend to the holder), the stock price should drop.

To calculate the amount of the drop, the traditional method is to view the financial effects

of the dividend from the perspective of the company. Since the company has paid say $x

in dividends per share out of its cash account on the left hand side of the balance sheet,

the equity account on the right side should decrease an equivalent amount. This means

that a $x dividend should result in a $x drop in the share price.

A more accurate method of calculating this price is to look at the share price and dividend

from the after-tax perspective of a share holder. The after-tax drop in the share price (or

capital gain/loss) should be equivalent to the after-tax dividend. For example, if the tax of

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capital gains Tcg is 35%, and the tax on dividends Td is 15%, then a $1 dividend is

equivalent to $0.85 of after tax money. To get the same financial benefit from a capital

loss, the after tax capital loss value should equal $0.85. The pre-tax capital loss would be

$0.85/(1-Tcg) = $0.85/(1-35%) = $0.85/65% = $1.30. In this case, a dividend of $1 has

led to a larger drop in the share price of $1.30, because the tax rate on capital losses is

higher than the dividend tax rate.

Finally, security analysis that does not take dividends into account may mute the decline

in share price, for example in the case of a Price–earnings ratio target that does not back

out cash; or amplify the decline, for example in the case of Trend following.

Other corporate entities

Cooperatives

Cooperative businesses may retain their earnings, or distribute part or all of them as

dividends to their members. They distribute their dividends in proportion to their

members' activity, instead of the value of members' shareholding. Therefore, co-op

dividends are often treated as pre-tax expenses. In other words, local tax or accounting

rules may treat a dividend as a form of customer rebate or a staff bonus to be deducted

from turnover before profit (tax profit or operating profit) is calculated.

Consumers' cooperatives allocate dividends according to their members' trade with the

co-op. For example, a credit union will pay a dividend to represent interest on a saver's

deposit. A retail co-op store chain may return a percentage of a member's purchases from

the co-op, in the form of cash, store credit, or equity. This type of dividend is sometimes

known as a patronage dividend or patronage refund, as well as being informally named

divi.

Producer cooperatives, such as worker cooperatives, allocate dividends according to their

members' contribution, such as the hours they worked or their salary.

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Trusts

In real estate investment trusts and royalty trusts, the distributions paid often will be

consistently greater than the company earnings. This can be sustainable because the

accounting earnings do not recognize any increasing value of real estate holdings and

resource reserves. If there is no economic increase in the value of the company's assets

then the excess distribution (or dividend) will be a return of capital and the book value of

the company will have shrunk by an equal amount. This may result in capital gains which

may be taxed differently than dividends representing distribution of earnings.

Mutuals

The distribution of profits by other forms of mutual organization also varies from that of

joint stock companies, though may not take the form of a dividend.

In the case of mutual insurance, for example, in the United States, a distribution of profits

to holders of participating life policies is called a dividend. These profits are generated by

the investment returns of the insurer's general account, in which premiums are invested

and from which claims are paid. The participating dividend may be used to decrease

premiums, or to increase the cash value of the policy. Some life policies pay

nonparticipating dividends. As a contrasting example, in the United Kingdom, the

surrender value of a with policy is increased by a bonus, which also serves the purpose of

distributing profits. Life insurance dividends and bonuses, while typical of mutual

insurance, are also paid by some joint stock insurers.

Insurance dividend payments are not restricted to life policies. For example, general

insurer State Farm Mutual Automobile Insurance Company can distribute dividends to its

vehicle insurance policyholders.

When a company distributes to its shareholders the profits earned by it, it is said that it

has paid dividends to its shareholders. Thus, dividend is the payment made by a company

to its shareholders out of its distributable profits. It is calculated as a percentage of the

nominal value of their shares, which is fixed for holders of preference shares and

20

fluctuating for holders of equity or ordinary shares. Distributable profits are the profits of

a company that are legally available for distribution as dividends.

Dividends are usually payable for a financial year after the final accounts are ready and

the amount of distributable profits is available. Dividend for a financial year of the

company (which is called 'final dividend') are payable only if they are declared by the

company at its annual general meeting on the recommendation of the directors. But

sometimes dividends are also paid by the directors themselves between two annual

general meetings without declaring them at an annual general meeting (which is called

'interim dividend').

The size of the dividend payment is determined by the Board of directors of a company,

who decide how much to pay out to shareholders and how much profit to retain in the

business; these amounts may vary from year to year. This is called 'recommendation of

dividend'. There is no specific provision in the Act to this effect. However, this is implied

from the provision in section 217(1)(c), according to which the Board of directors must

state in the Directors' Report the amount, if any, which it recommends should be paid by

way of dividend.

The dividend recommended by the Board of directors in the Board's Report must be

'declared' at the annual general meeting of the company. This constitutes an item of

ordinary business to be transacted at every annual general meeting. This does not apply to

interim dividend. 

SEBI GUIDELINES

Provisions governing declaration and payment of dividend

 

The provisions governing declaration and payment of dividend by a company are

provided in the Companies Act, 1956 (referred to as “Act”) and the Rules made there

under including the Companies (Transfer of Profits to Reserve) Rules, 1975, Companies

(Declaration of Dividend out of Reserves) Rules, 1975. Further, in case of companies

listed on the Stock Exchanges, the relevant clauses of Listing Requirements are to be

21

followed. The Companies Act allows dividends to be paid out of three sources namely (a)

Profits of the company for the year for which dividends are to be paid. (b) Undistributed

profits of the previous financial years. (c) Moneys provided by the Central Government

or a State Government for the payment of dividends in pursuance of a guarantee by the

Government concerned.  

 

Determination of Dividend

 

Section 205 of the Act only prescribes that dividend shall be paid out of profits of the

company. As dividends can only be declared out of surplus earnings, there must be an

exact method of determining whether surplus earnings for that purpose actually exist. But

the Companies Act do not provide any guidance in this regard. In the matter

of Hariprasad Vs. Amalgamated Commercial Traders  the Chief Justice of Madras High

Court observed that the Companies Act, 1956 does not say further how those profits have

to be ascertained. There is nothing at all in the Act about how dividends are to be paid,

nor how profits are to be reckoned; all that is left and very judiciously and properly left,

to the commercial world.

 

Further, it has become obligatory for a company to provide for depreciation as required

by Section 205(2) of the Act. Depreciation has to be provided for the current year as well

as for arrears of depreciation if any. It further states that the depreciation must be

provided to the extent specified in the Section 350 of the Act. If we refer this Section, it

states that the depreciation is to be calculated at the rate specified in Schedule XIV of the

Act. Further, it is to be noted that if the Act makes no provision for a particular kind of

asset, then its depreciation may be worked out on a basis approved by the Central

Government in this regard. A company has got two choice to arrive at depreciation i.e.

either to adopt the above said procedure or to work out depreciation by dividing ninety

five percent of the original cost of the depreciable asset by the specified period in respect

of such asset.

 

22

But, if any asset is sold, discarded, demolished or destroyed for any reason before

depreciation for such asset has been provided for in full, the excess, if any of the written

down value of such asset over its sale proceeds or its scrap value shall be written off in

the financial year in which it is sold. It is to be noted that the Act does not require any

provision to be created for depletion of a wasting asset.

 

Further, the previous years’ losses, if any must also be set off against the profits of any

subsequent  year or years before any dividend can be paid.

 

The proviso (c) of Section 205(1) of the Act empowers the Central Government to waive

in any particular case, the requirement of providing for depreciation.  The word loss also

includes depreciation (as declared in the case of Garden Silk Weaving Factory Vs.

CIT (1991) SC). There is no reason to give the word “loss” as used in Section 205 a

different meaning from one in which it is ordinarily understood only because it has to be

read with Section 115 of the Income Tax Act, 1961 (V.V.Trans-Investments (P) Ltd Vs

CIT (1999) SC)    

 

Declaration of Dividend

A company cannot declare dividend in the following circumstances:-

 

a)      When a Company is not having profit i.e. is a loss making company.

b)      When a Company fails to redeem its preference shares as per the provisions of

Section 80A of the Companies Act. (Sub Section 2B)

 

Further, a Company cannot declare a dividend without the prior approval of Financial

Institution, in case if the covenants of the loan agreement stipulates in this regard. Section

205(3) stipulates that no dividend shall be payable except in cash.  

 Dividends cannot be declared out of the Securities Premium Account or the Capital

Redemption Reserve Account or Revaluation Reserve or Amalgamation Reserve or out

of the Profit on re-issue of forfeited shares or out of profit earned prior to the

incorporation of the Company. 

23

Compulsory Reserves

 

Section 205 (2A)  of the Act prescribes that before any dividend is declared or paid,

certain percentage of profits as may be prescribed by the Central Government, but not

exceeding 10% will have to be transferred to the reserves of the Company.  The company

may, however, voluntarily create more than the prescribed percentage and transfer to the

reserves of the Company. If in a particular year, on account of inadequacy of profit, the

company has to pay dividends out of the previous year’s reserves, it should follow such

rules as may be made by the Central Government. In case of any deviation from such

rules, then the company can do so only with the previous approval of the Central

Government. The term “Reserve” meant in the said Rules means “Free Reserves” i.e.

reserve which are not created or set apart or intended for any special purpose. For e.g.

Development Rebate Reserve, Capital Reserve or Special Reserve will not come under

the category of free reserves for the purposes of this rule. 

 

According to the Companies ( Transfer of Profits to Reserves) Rules 1975, before

declaration or payment of dividend, profits shall be compulsorily transferred to reserves

at the following rates:-

 

Rate of proposed dividend                               Amount to be transferred to Reserves

Not exceeding 10%                                            Nil

Exceeding 10% but not exceeding 12.5%         2.5% of  current profits

Exceeding 12.5% but not exceeding 15%         5% of current profits

Exceeding 15% but not exceeding 20%            7.5% of current profits

Exceeding 20%                                                  10% of current profits.

 

 Under the Companies Bill 2009, it is left to the discretion of the company to determine

the percentage of profits to be transferred to reserves.

24

Capitalisation of Profits

 

The proviso to Section 205 further states that there is no prohibition for capitalisation of

profits or reserves for the purpose of issuing fully paid up bonus shares or paying up any

amount for the time being unpaid on any shares held by the members of the company.

Thus, a company may in general meeting, on the recommendation of the Board of

Directors resolve and convert into capital any sum standing to the credit of profit or loss

account or reserve fund account or otherwise available for distribution. As a general rule

only such funds can be capitalised as would be available for dividend distribution.

 

Entitlement -Equity Shareholders

 

A company can pay dividend only to the shareholders of that company

 

a)   whose name appears on the Register of members maintained by the Company (in

case the shares are held in physical form) or

b)   whose name appear on the register of beneficial owners maintained by a

      depository (in case the shares are held in dematerialised form)

Preference shareholders

(a) Preference shares carry a preferential right as to dividend in accordance with the terms

of the issue and the Articles, and hence preference shareholders are paid dividend before

the dividend is paid to the equity shareholders of the company.

(b) Preference shares may be cumulative or non-cumulative. Dividend in arrears on

cumulative preference shares can be paid in the subsequent years where there are profits

sufficient for such payment. In case of non-cumulative preference shares, if no dividend

is paid in a year, there is no right to receive it in future years.

Further if any shares are delivered to a Company for registration and the same have not

been registered by the Company then any dividend to be paid on those shares need to be

transferred to the unpaid dividend account.

25

Dividend entitlement for shares with Differential voting rights/dividend

As per Section 86(a) (ii) of the Companies Act, 1956 and also according to the

Companies ( Issue of Share Capital and Differential Voting Rights) Rules, 2001, a

company can issue shares with differential rights as to voting as well as dividend subject

to fulfilment of certain conditions given thereunder. In fact such issue of shares with

Differential voting rights were also upheld by Company Law Board in Anand  Pershad

Jaiswal Vs.Jagatjit Industries Limited.(2009) stating that issue is well within the scope of

Section 86 of the Companies Act as well as the Companies ( Issue of Share Capital and

Differential Voting Rights) Rules, 2001. In this connection, it must be stated that CLB

did not have the opportunity to get into much deeper details of this case, as it was settled

through a consent order. Based on this judgement, a limited number of companies have

come forward to issue shares with differential voting rights as well as dividend. Tata

Motors is one such example which had issued shares both with differential rights as to

vote as well as dividend.

 

In July, 2009 SEBI amended the Listing Agreement to state that listed Companies are

prohibited from issuing shares with “superior” voting rights and Clause 28A was inserted

in the Listing Agreement. It states that “ The Company agrees that it shall not issue

shares in any manner which may confer on any person, superior rights as to voting or

dividend vis-à-vis the rights on equity shares that are already listed.”  So, after this

amendment a Company whose equity shares are already listed on the Stock Exchange,

cannot issue shares in any manner conferring superior rights as to voting and dividend on

equity shares.

 

It is to be noted that under Clause 37 of the Companies Bill, 2009, the different kinds of

share capital which can be issued by a company excludes issue of equity share capital

with differential voting rights. Thus, the Companies Bill prohibits issue of equity share

capital with differential voting rights as well as differential dividend. But there is no

transitory provision in the Bills for those companies which had already issued share

capital with differential rights or dividend. So, it is utmost necessary that the Bill should

include certain period to allow the companies which had issued equity share capital with

26

differential voting or dividend to bring back their capital structure in accordance with the

provisions of the Bill.

 

Declaration of dividend out of profits earned by earlier years

 Section 205 of the Act, provides that a company can declare dividend out of the profits

of the previous years. But, Clause 110 of the Companies Bill, 2009 stipulates further

conditions to declare dividend in such cases. It stipulates that if owing to inadequacy  or

absence of profits in any Financial Year, the Company proposes to declare dividend out

of the profits of the previous financial year or years and transferred to its reserves, such

declaration shall be passed by a resolution at the Board Meeting with the consent of all

the directors and approval of the financial institution whose term loans are subsisting and

also to be passed by the shareholders by a special resolution at the Annual General

Meeting. Already the Ministry has received suggestions, stating that the resolution passed

by the Board should be approved by all the directors present at the Board Meeting and

not by with the consent of  all the directors of the company.     

 

Procedure for declaration of Dividend 

A company which intends to declare and pay dividend should adopt the following

procedures.  Further, in case the company’s shares are listed on the Stock Exchanges,

additional requirements relating to Listing Agreements are to be followed.

 

1) Recommendation by Board of Directors:-

 Dividend can be declared only on the recommendation of the Board of Directors of the

Company. The shareholders do not have any power to declare any dividend.  The Board

of Directors after considering and approval of the financial statements of the Company,

determines the rate of dividend to be declared and then recommends the same to the

shareholders. For this purpose, a Board Meeting shall be convened to pass the resolution

for a) rate of dividend and the amount of dividend to be paid. b) book closure date for

dividend purposes c) date of annual general meeting d) Bank with which the account

shall be opened for the purpose of remittance of dividend.

 

27

2) Approval by the Shareholders:-

 The dividend recommended by the Board of Directors is declared by a resolution passed

at the Annual General Meeting by the shareholders. The declaration of dividend should

form part of an ordinary business item to be transacted in the notice of the Annual

General Meeting. While approving the rate of dividend at the Annual General Meeting,

the shareholders have power to declare a lower rate of dividend than what is

recommended by the Board but they have no power to increase the amount or the rate of

dividend so recommended by the Board of Directors. Dividend when declared becomes

debt against the company.

 

3) Dividend now includes interim dividend:-

 After the Companies (Amendment) Act, 2000, interim dividend is now recognised as a

part of final dividend (clause 14A of Section 2). Interim dividend can be declared by the

Board of Directors and they have authority to do so. Further, the provisions contained in

Section 205, 205A, 205C, 206, 206A and 207 shall apply to interim dividend.  

 

4) Dividend to be deposited in a separate bank account:-

 The Company should deposit the dividend amount ( including interim dividend) within 5

days of its declaration in the separate bank account opened for this purpose. It means that

the interim dividend will have to be deposited in a bank account within 5 days of the

Board Meeting whereas final dividend will have to be deposited within 5 days from the

date of Annual General Meeting in which it was approved by the shareholders. Also

Section 205 (1B) stipulates that the amount so deposited shall be used only for the

purpose of payment of dividend ( whether interim or final).

 

5) Dividend to be paid by cheque or warrant

 Section 205(5)(b) of the Companies Act, 1956 provides that the dividend payable in cash

may be paid either by cheque or warrant.

 

28

6) Time frame for payment of dividend

 As per Section 207 of the Companies Act, 1956, the dividend warrants shall be

despatched within 30 days of declaration of dividend.

 

7) Transfer of unpaid dividend

 As per Section 205A of the Act, where a dividend has been declared by a company but

has not been paid (or claimed) within 30 days from the date of declaration to any

shareholder entitled to the said payment of dividend, the Company shall within 7 days

from the expiry of the said period of 30 days transfer the total amount of dividend which

remains unpaid or unclaimed within the said period of 30 days to a special account to be

opened by the Company in that behalf with any Scheduled Bank which is called “unpaid

Dividend Account of ----- company Limited. Interest at the rate of 12% p.a. is payable by

the Company for delay in making the above transfer.

 

8) Transfer of unpaid or unclaimed dividend to the Investor Education and

Protection Fund:-

 Any amount of dividend which remains unpaid or unclaimed for a period of 7 years from

the date it became due for payment shall be transferred by the company to the Investor

Education and Protection Fund. When making a transfer to the Fund, the Company shall

furnish to the authority appointed by the Central Government, the details relating to a) all

sums included in such transfer b) nature of the sums, c) names and last known addresses

of the persons entitled to receive the sum. D) the amount to which each person is entitled

and such other particular as the case may be prescribed. The said fund shall be utilised for

promotion of investor awareness and protection of the interests of investors in accordance

with the Investor Education and Protection Fund Rules, 2001.

 

Further as per Section 205B of the Act, once any amount on account of unpaid /

unclaimed dividend has been transferred to the Investor Education and Protection Fund in

pursuance of Section 205C, no claim, for payment for any sum, from any person shall be

entertained by the Fund. Thus, any person claiming to be entitled to any dividend 

 

29

Clause 113 of the Companies Bill 2009 stipulates that the amount lying in the Investor

Education and Protection Fund established under section 205C of the Companies Act,

1956 shall stand credited to the Investor Education Protection Fund established under sub

section (1) of Section 112 of the said Bill. Further Clause 112 of the Bill stipulates that

the fund shall be utilised for the refund in respect of unclaimed dividends, application

monies due for refund and interest thereon etc. which is different from the present

provisions. Also, the said fund shall be used for protection of investors’ education,

awareness and protection in accordance with the Rules as may be prescribed. 

9) Directors Report

 Section 217(1)(c) of the Companies Act, 1956 requires that the report of the Board of

directors shall state the amount, if any, which it recommends should be paid by way of

dividend. The Board may choose not to declare any dividend even though the company

has made profit and the same be captured in the Directors Report with reasons.  

 

Compliance relating to Listing Agreement:--

 1) Clause 12A (4)

As per this clause, the company should adhere to the provisions of Section 206A as well

as Section 27 of the Securities Contracts (Regulations) Act, 1956, wherein it is the duty

of the company to keep dividend, offer of rights shares and bonus shares in abeyance in a

situation where such dividend, right etc. are declared in the interval between lodgement

of a valid instrument for transfer of shares with the company and its eventual registration.

2) Clause 16

The Company agrees to close its transfer books for the purpose of declaration of dividend

and will give notice to the Stock Exchange at least 7 working days in advance of the date

of closure of transfer books and will also intimate the purpose for which the transfer

books are closed. Regarding the book closure, advertisement should be issued  in the

newspapers and copies of such advertisements shall be sent to Stock Exchanges ( As per

Section 154 of the Companies Act, 1956).

 

30

3) Clause 19

The company will give prior intimation to the Stock Exchange about the Board Meeting

at which proposal for recommendation of dividend and or passing over of dividend due to

be considered at least 2 working days in advance. Further, the Company will recommend

or declare dividend at least 5 days before commencement of the closure of its transfer

books. 

 

4) Clause 20A

The company agrees to declare and disclose the dividend on per share basis only.

 

5) Clause 21

The Company will fix and notify the Stock Exchange at least 21 days in advance of the

date on from which the dividend on shares will be payable and will issue simultaneously

the dividend warrants/cheques which shall be payable at par at such centres as may be

agreed to between the Exchange and the Company and which shall be collected at par,

with collection charges, if any, being borne by the Company, in any bank in the country

at centres other than the centres agreed to between the Exchange and the company so as

to reach the holders of shares on or before the date fixed for payment of dividend.

 

6) Clause 28A

The Company agrees that it shall not issue shares in any manner which may confer on

any person, superior rights as to voting or dividend vis-à-vis the rights on equity shares

that are already listed.

           

7) Clause 34

 The Company agrees that it will not forfeit unclaimed dividends before the claim

becomes barred by law and that such forfeiture, when effected will be annulled in

appropriate cases. Further, the Company agrees that if any amount be paid up in advance

of calls on any shares, it will stipulate that such amount may carry interest but shall not in

respect thereof confer a right to dividend or to participate in profit.

 

31

8) Clause 41

 In respect of requirements as to financial figures, the Company shall disclose the

following to the Stock Exchanges, the dividends paid or recommended for the year,

including interim dividends:-

a)   the amount of dividend distributed or proposed for distribution per share and the

amounts in respect of different classes of shares shall be distinguished and the

nominal values of shares shall also be indicated.

b)   Where dividend is paid or proposed to be paid pro-rata for shares allotted during

the year, the date of allotment and number of shares allotted, pro-rata amount of

dividend per share and the aggregate amount of dividend paid or proposed to be

paid on pro-rata basis.

9) Clause 49 

In respect of complaint received from any shareholder regarding non-receipt of dividend,

a board committee under the chairmanship of a non-executive director shall be formed to

specifically look into the redressal of shareholder. This Committee shall be designated as

‘Shareholders/Investors Grievance Committee’. Further, under the matters to be placed

before the Board Meeting, one of the item is to place the non-compliance relating to

payment of dividend. Hence a listed company will have to compulsorily place before the

Board of Directors any grievances relating to shareholders with respect to non-payment

of dividend.

 

10) Shareholders’ Information under Corporate Governance Report 

Under the Corporate Governance Report, the dividend payment date should be mentioned

under the heading “ Shareholders’ Information”.

 

Interim Dividend –Whether a statutory debt

The declaration of an interim dividend does not create a debt against the

company.  Dividends can be declared only by a resolution of the shareholders in

accordance with the Directors’ recommendation at a general meeting. But, if so permitted

by the Articles of Association of the company, the Directors can declare an interim

32

dividend between two Annual General Meetings. While declaring interim dividend, the

Board should carefully assess and examine the financial statements and should ensure

that the company has adequate profits. However, it does not create a debt enforceable

against the company, because, the Directors can very well rescind the resolution before

payment. Thus, the shareholders do not get any vested right under a Directors’ resolution

declaring an interim dividend. It is to be noted that Section 207 of the Companies Act

which applies to interim dividend also, stipulates penalty for failure to distribute dividend

to the shareholders within 30 days of its declaration. The penalty prescribed under the

Act is that the directors shall be punishable with simple imprisonment of three years

along with a fine of Rs.1000 for every day during which such default continues and the

company shall be liable to pay simple interest at the rate of 18% p.a. during the period for

which such default continues. Further, since the penalty prescribed is by way of both fine

and imprisonment, the offence is also not compoundable under Section 621A of the

Companies Act. Thus, going by the principle, in law one cannot take advantage of his

own default, the Board of Directors have got power to rescind the payment of dividend

only upto the 29th day of its declaration and not thereafter. It is because, after the 30 th day,

it becomes a statutory default. 

Clause 110(3) of the Companies Bill, 2009 also stipulates that the board of directors of a

company may declare interim dividend during any financial year out of the profits of the

company for part of the year. 

 

When dividend need not be paid

 In the following cases, a company need not pay dividend within 30 days from the date of

declaration:-

a)   Where dividend could not be paid by reason of the operation of any law.

b)   Where a shareholder has given directions to the company regarding payment of

dividend and those directions cannot be complied with.

c)   Where there exist a dispute regarding the right to receive the dividend.

d)   Where dividend is lawfully adjusted by the company against any sum due to its

from the shareholder.

33

e)    Where the non-payment of dividend is not due to any default of the company. 

  

Conclusion 

The payment of dividend will instil confidence to the shareholders of the company, after

all a company can declare and pay dividend only if it makes profit. Further, payment of

dividend consistently over a period of time would enhance the image of the company.

The company would also stand to benefit as whenever it requires additional funds for

expansion, it can very easily tap the capital markets (as investors would be ready and

willing to invest) without resorting to huge borrowings from Banks and Financial

Institutions. The shareholders can be rewarded by other means i.e. declaring bonus

shares, rights shares etc. but since dividend is paid in cash it is considered one of the best

reward a company can do to its shareholders for enhancing their wealth. The shareholders

also enjoy additional benefit since the dividend which they receive is tax free and need

not pay any tax on dividend.

34

Chapter 2REVIEW

OFLITERATURE

35

The researchers and academicians in India as well as abroad have made contribution in

their researches on dividend policies and announcement effect of dividends on stock

price

Lynn R(1991) examined the importance attached to revenue forecasts by firms and the

market and whether these forecasts were value-relevant conditional on earnings forecasts.

The study was divided into parts. First, it examined whether the capital market reaction to

earnings and revenue announcements had an association with revenue forecast errors

conditional on earnings forecast errors. Second, it investigated existence of differential

valuation effects associated with meeting or exceeding analysts’ revenue expectations

over and above meeting/exceeding analysts’ earnings expectations.

Carol P (1993) tested the signaling and free cash flow hypotheses of the information

content of share repurchases using UK open market share repurchases between January

1999 and December 2004. The five day mean announcement abnormal return of the

sample was low at 1.28% but it was statistically significant at the 5% level.

Ganapathi N (1995) identified previously undocumented source of predictable cross-

sectional variation in Standardized Unexpected Earnings’ autocorrelations viz. the sign of

the most recent earnings realization and presented evidence that the market ignored this

variation (loss effect). It was possible to earn returns higher than from the Bernard and

Thomas strategy by incorporating this feature.

Minnick N and Kristina L. (1996) examined the cross sectional determinants of the

decision to take write offs. A hand collected dataset on write-offs was used that was

much more comprehensive than existing write-off datasets. It was found that quality of

governance was positively related to write-off decisions in the cross section. The results

36

also suggested that poor governance companies waited to take write-offs until it became

inevitable while well-monitored companies took write-offs sooner.

Hardjo K (1998) examined in their study whether managers deliberately used accruals to

convey information regarding firm future profitability. The contemporaneous earnings

and dividend announcement data was used as research setting as it reduced the possibility

of opportunistic income smoothing by managers and hence increased the validity of the

inference on the accrual signaling hypothesis.

Kanwal A (2001) observed profitability as always been considered as a primary indicator

of dividend payout ratio. Apart from profitability, numerous other factors like cash flows,

corporate tax, sales growth and market to book value ratio were also considered rampant.

Juho K(2003) examined stochasticity of stock return volatility by questioning the

assumption that the conditional expectations of future dividends react to the same new

information. The stochastic evolutions of conditional dividend expectations were

characterized by extending the information process to dividend paying stocks.

Paul H(2004) examined how institutional investors respond to accounting restatements.

The study showed that transient institutional investors defined as institutions with shorter

investment horizons and higher portfolio turnover significantly reduced their holding in a

restating firm at least one quarter prior to the quarter of the restatement. He examined the

relation between revenue surprises and future stock returns. The study investigated how

analysts updated their earnings forecasts followed by announcements of revenue and

earnings surprises. The results indicated that the stock price reaction on the earnings

announcement date was significantly related to both revenue surprises and earnings

surprises.

Yael V and Janice Y (2006) examined the effects of venture capital backing on the

corporate governance of the firm following the IPO. The study conducted three

independent sets of tests which examined effectively how governance and monitoring

37

differed for venture and non-venture backed firms. observed that in a relatively less

litigious environment like Australia it was common to find IPO firms that voluntarily

provided forecasts in their prospectus. 158 Australian industrial IPOs listed from 1991 to

1997 were used in the study to examine the impact of the disclosure and accuracy of

earnings and dividend forecasts on equity pricing.

Nikolaos F and Elaine H(2008) discovered that existence of a long term dividend policy

stood partly unaffected by the level of current period earnings. He presented a theoretical

model on dividend policy for distributed profit taxation which is the corporate taxation

regime of Estonia. He examined market reactions to firm’s earnings announcements. The

study extended the examination to include a broad range of concurrent disclosure

contained in earnings press releases, the financial disclosures captured as accounting

ratios and verbal components of disclosure which were captured using elementary

computer based content analysis.

Gil S and Apostolos D(2011) examined negative tunneling within a chaebol and used a

large sample of earnings announcements made by firms belonging to Korean chaebols.

The study found out that the announcement increased (decreased) earnings over the

previous year by a chaebol-affiliated firm had a positive (negative) effect on the

abnormal return for the value -weighted portfolio of other non-announcing affiliates in

the same group. He investigated the stock market reaction of the Athens Stock Exchange

to cash dividend announcements for the period 2000-2004. In particular, the study

examined both the stock price and trading volume response to company announcements

about dividend distributions. The dividend distribution in Greece featured remarkable

differences from those of US, UK and other developed markets.

38

Chapter 3NEED, SCOPE

&OBJECTIVES

39

3.1 Need

After conducting a review of researches done by various professionals, gaps have been

identified. The researcher had analyzed that stock prices react positively to the dividend

increase announcements. But a few researchers had studied whether changes in dividend

policy affect the efficiency of the stock market announcing these changes; via stock

prices, and what can be the reasons for the stock price reactions, on announcements of

dividend policy and how to analyze the stock price behavior around one particular

dividend policy i.e. dividend increase. This had been identified and had led to the current

research being undertaken. In this, all the aspects of need had been tried to cover.

3.2 Scope

The scope of the study was limited to the BSE companies listed in BSE 500 covering the

time period from 2006 to 2012

3.3 Objectives

Following were the various objectives for carrying out the study:

To analyze the reasons for stock price reactions on dividend announcements.

To analyze the stock price behavior around one particular dividend policy i.e.

dividend increase and to further test for information signaling hypothesis.

To analyze whether changes in dividend policy affect the efficiency of the stock

market on announcements.

3.4 Testing of Hypothesis

To empirically prove the above objectives, the null hypotheses were framed as follows:

Watts (1973), Woolridge (1983), Rao (1994) and Bjaj and Vijh (1995) recognized the

positive impact of dividend increase announcements on stock prices as a confounding

40

event and assessed weather dividend announcements have greater information content.

Travles and Vafeas (2001) and Fuller and Thakor (2002) found a positive market

reaction to dividend increase announcements and experience a higher abnormal returns in

response to dividend change.

H01: Dividend increase has no effect on the stock price returns meaning thereby that the

average abnormal returns around the announcement will be zero.

H02: The stock market will be inefficient meaning thereby that the cumulative abnormal

returns will be far away from zero (on the tenth trading day after the formal

announcement i.e. event).

41

Chapter 4RESEARCH

METHODOLOGY

42

RESEARCH METHODOLOGY

Research is a common parlance which refers to search for knowledge. It is a procedure of

logical and systematic application of the fundamentals of science to the general and

overall questions of a study and scientific technique, which provide precise tools, specific

procedures, and technical rather philosophical means for getting and ordering the data

prior to their logical analysis and manipulating different type of research designs is

available depending upon the nature of research project, availability of manpower and

circumstances.

According to D. Slesinger and M. Stephenson research may be defined as” the

manipulation of things, concepts or symbols for the purpose of generalizing to extend,

correct or verify knowledge, whether that knowledge aids in the construction of theory or

in the practice of an art”. Thus it is original contribution to the existing stock of

knowledge of making for its advancement. In short, the search of knowledge through

objective and systematic method of finding solution to a problem is research.

4.1 Research Design

A research design is the arrangement of conditions for collection and analysis of data in a

manner that aims to combine relevance to the research purpose with economy in

43

procedure. In fact, the research design is the conceptual structure within which research is

conducted. This research was descriptive, quantitative and conclusion-oriented in nature.

4.1.1 Conclusion-Oriented Research

The research was a conclusion Oriented research because this research aimed at

highlighting the stock price reaction to the dividend increase announcements.

4.1.2 Descriptive Research

The research was a descriptive research. Descriptive studies, as the name implies was

concerned with specific predictions, with narration of reasons for stock price reactions on

dividend announcements.

4.1.3 Quantitative Research

The research was quantitative as the concerned topic can be measured in numeric terms

only and contains quantitative factors.

4.2 Data Collection and Analysis

4.2.1 Data Collection

The secondary data was used for data collection.

4.2.1.1. Secondary Data

Secondary data is the data collected from already been use or published information like

journals, diaries, books, etc. In this research project, secondary data was collected in

following ways:

The secondary data was collected through the websites of BSE.

4.2.2 Data Analysis

4.2.2.1 Tools of Presentation

It means what all tools are used to present the data in a meaningful way so that it

becomes easily understandable. In this research tables were used for presenting the data.

4.2.2.2 Tools of Analysis

44

In this research, to study the impact of the announcement of dividend increase, on the

stock return, a methodology i.e., the standard event study methodology with the market

model to estimate the normal return for a security had been employed.

4.2.2.2.1 Standard Event Study Methodology

The market model assumes a linear relationship between the return of the security to the

return of the market portfolio. The BSE 500 Sensex had been taken as the benchmark

index. The stock returns had been regressed to BSE 500 Sensex returns for a period of

120 trading days ending ten trading days before the announcement date. The ‘α’ and ‘β’

so calculated had been used to calculate the expected abnormal returns for the event

window, starting ten trading days before the event to ten trading days after the event.

The abnormal return for each of the day in the event window was the difference between

the actual stock return during that day and the expected normal return according to the

BSE 500 Sensex as per the ‘α’ and ‘β’ of the concerned stock.

For being able to draw overall inference on the abnormal returns, the abnormal returns

for the scrips were summed up trading day wise. This gave the average abnormal return

for each trading day‘t’ in the event window. Then, the cumulative average return was

computed for each trading day‘t’ in the event window by adding AAR of each period.

In brief, this approach involved the following sequence:

Daily abnormal returns for the security ‘i’ from 121 days before to 120 days after the

announcement (including announcement day) of the dividend increase had been

computed as:

ARi,t = Ri,t – E(Ri,t)

Where t = day measured relative to the dividend increase announcement day (t=0)

ARi,t = abnormal return on security ‘i’ for day ‘t’

Ri,t = raw return on security ‘i’ for day ‘t’ which was calculated as:

45

Ri,t =

Where MPi,t = market price of security ‘i’ on day ‘t’

MPi,(t-1) = market price of security ‘i’ on day ‘t-1’

E(Ri,t) = expected return on security ‘i’ during day ‘t’ which had been estimated through

market model using BSE 30 Sensex as follows:

E(Ri,t) = α1 + β1Rm + εi

Where Rm = return on the BSE 30 Sensex and α1, β1are the parameters of the market

model and εi is assumed to indicate the abnormal returns.

Average abnormal returns for each relative day had been calculated by:

AARi = i,t

Where N = Number of securities with abnormal returns during day‘t’.

4.3 Limitations of Study

The following were the limitations of the study:

4.3.1 Shortage of Time

The time period of study was very limited. It was very difficult to have in detail study on

project work due to limited time period. The period of 4 to 6 weeks was not enough for

the proper study of the project.

4.3.2 Inadequate Data

The data provided was not up to the mark due to which we faced problems in the

research.

46

4.3.3 Lack of Scientific Method

The lack of scientific training in methodology of research was great impediment in this

research program, which led to the delay of research.

Chapter 5

DATA ANALYSIS

47

& INTERPRET

ATION

Event Study Results

Abnormal returns are calculated using the market model. The study of Cable and Holland

(1999) argued that the market model compares favorably to other models proposed in the

literature. For that reason, reference has been made only to the results from the market

model. Table 7 outcome is based on cumulative average abnormal returns (CAAR)

results of 50 companies dividend announcements for trading days -120 to +120.

Table 7: Cumulative Average Abnormal Returns Results

Merger Announcements Cumulative Average Abnormal Return in %

(p-values)

Pre- -120 to -1 2.1303(.000)*

48

Announcement -90 to -1

-60 to -1

2.2402(.000) *

1.7746(.000) *

-30 to -1 1.6892(.000) *

-10 to -1 2.0497(.000) *

.Post-

Announcement

+1 to +10 .9737(.000) *

+1 to +30 .3037(.121)

+1 to +60

+1 to +90

-.7966 (.000) *

-1.3918(.000) *

+1 to +120 -1.2980(.000) *

Source: Author’s Own.

*Significant at .05 level

Inspection of Table 7 reveals that the pre-announcement and post-announcement periods

contain little new information. The results confirm the notion that the stock returns react

very strongly to dividend announcements both during the pre-announcement and post-

announcement period. It can be observed that the market witnessed positive abnormal

returns in the pre-announcement periods. In order to further testify the association

between pre and post returns due to dividend for corporations (refer table 8), paired t-test

has been applied for different event windows: very short (-10 to +10 days), short (-30 to

+30 days), medium (-60 to +60 days) and long (-120 to +120 days).

Table 8: Pre and Post CAAR: Results of Paired t-test

Event Windows (p-values)

-10 to + 10 .000*

-30 to +30 .000*

-60 to +60 .000*

-120 to +120 .000*

Source: Author’s Own.

*Significant at .05 level

49

It can be observed from the results of paired t-test presented in table 8 that the market

witnessed positive abnormal returns during the entire period under study, indicating that

the impact of dividend announcements on the share prices for all windows, insignificant

results have been obtained. The findings indicated the presence of lag in reflecting and

adjusting the effects of merger announcements by Indian stock market, thereby, giving

chance to the investors to earn abnormal returns. Considering the momentum of the share

price adjustment to the new information coming from dividend announcements, it has

been observed that there is lagging response to the same, thus, indicating the inefficiency

of the Indian stock market. It reveals that Indian stock market responds to the corporate

news contained in dividend announcements for all event windows starting from very

short event windows and continuing upto the largest window for the current study, giving

enough chance to the investors to beat the market, and hence, generating abnormal

returns. On the basis of the results, the null hypothesis (H02) of insignificant (zero) share

price response to merger announcements and has been rejected. Also from the results it

can be inferred that Indian stock market possesses information inefficiency as the effects

are shown in shorter as well as longer duration of any announcements as the investors are

given chance to earn the abnormal returns. Thus, the null hypothesis (H03) that Indian

stock market is efficient has been rejected.

The perusal of the results on the basis of accounting performance measures and event

study reflect that there is significant impact of dividend announcements on the financial

performance and share prices.

50

51

Chapter 6FINDINGS OF THE

STUDY

52

FINDINGS OF THE STUDY

The findings of the study are presented below in the best possible way. For this we have

studied the Indian stock market and have applied t - test for the same and have seen that

null hypothesis have been rejected. The perusal of the results on the basis of accounting

performance measures and event study reflect that there is significant impact of financial

results announcements on the share prices. The findings are presented below:

It can be observed from the results of paired t-test that the market witnessed

positive abnormal returns during the entire period under study. The findings

indicated the presence of lag in reflecting and adjusting the effects of merger

announcements by Indian stock market, thereby, giving chance to the investors to

earn abnormal returns.

Considering the momentum of the share price adjustment to the new information

coming from financial results announcements, it has been observed that there is

lagging response to the same, thus, indicating the inefficiency of the Indian stock

market.

It reveals that Indian stock market responds to the corporate news contained in

financial results announcements for all event windows starting from very short

event windows and continuing up to the largest window for the current study, thus

giving enough chance to the investors to beat the market, and hence, generating

abnormal returns.

On the basis of the results, the null hypothesis (H01) of insignificant (zero) share

price response to financial results announcements and has been rejected.

Also from the results it can be inferred that Indian stock market possesses

information inefficiency as the effects are shown in shorter as well as longer

duration of any announcements as the investors are given chance to earn the

abnormal returns. Thus, the null hypothesis (H02) that Indian stock market is

efficient has been rejected.

53

Chapter 7CONCLUSION

54

CONCLUSION

For studying the impact of stock prices on financial results, we have studied the Indian

stock market and have studied in detail 50 companies of Bombay stock exchange. The

detail study includes the last announcement date of financial results for quarter 4

corresponding to the close price and BSE-500. We have taken 121 days prior to the

announcement date and 120 days after the announcement date for studying the impact of

stock prices on financial results. Thereafter, t – test have been applied and it is observed

that null hypothesis has been rejected.

In a nutshell, we observed that the market witnessed positive abnormal returns during the

entire period under study. The findings indicated the presence of lag in reflecting and

adjusting the effects of merger announcements by Indian stock market, thereby, giving

chance to the investors to earn abnormal returns. Considering the momentum of the share

price adjustment to the new information coming from financial results announcements, it

has been observed that there is lagging response to the same, thus, indicating the

inefficiency of the Indian stock market. It reveals that Indian stock market responds to

the corporate news contained in financial results announcements for all event windows

starting from very short event windows and continuing up to the largest window for the

current study, giving enough chance to the investors to beat the market, and hence,

generating abnormal returns. On the basis of the results, the null hypothesis (H01) of

insignificant (zero) share price response to financial results announcements and has been

rejected. Also from the results it can be inferred that Indian stock market possesses

information inefficiency as the effects are shown in shorter as well as longer duration of

any announcements as the investors are given chance to earn the abnormal returns. Thus,

the null hypothesis (H02) that Indian stock market is efficient has been rejected.

Thus, it has been observed that the accounting performance measures and event study

reflect that there is significant impact of financial results announcements on the share

prices.

55

REFERENCES

56

Lynn R   (1991) “Stock Markets:

http://www.independent-stock-investing.com/Dividends-Declared.html”.pp95-14

Carol P(1993) “ Effect of dividend announcement on atock market- An

Empirical”, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=981885 ,Vol. 19,

Ganpathi N (1995) “Dividend announcements and the abnormal;stock returns

RIVALS”http://www.skirec.com/images/download/apjrbm/APJRBM-DEC-10/13.pdf

Nomura Capital Market Review, Vol. 8, No.3, pp. 14-20, Autumn 2005  

Minnick N (1995) “The Behavior of Stock Market Prices. Journal of Business,38,

34-105

Hardjo K (1996) “Dividend Policy, Growth and the Valuation of Shares. Journal

of Business, 34, 411-433Vol. VIII, No. 9, pp. 7-17,

Kanwal A. (2000). The Effect of Annual Earnings Announcements on the Indian

Stock Markets. International Advances in Economic Research, 12, 318-326

Juho K(2003) The impact of initiating dividend payments on shareholders’

wealth, Journal of Business 56, 77-96.

Nikolaos F (2008) “Abnormal Stock Returns for the Event Firm and its Rivals,

following the Event Firm’s Large One Day Stock Price Drop. Journal of

Managerial Finance,37,151-172

Gil S (2011) “The Response of Stock Prices to Permanent and Temporary

Shocks to Dividends. Journal of Financial and Quantitative Analysis, 30, 1-22.

57

58

ANNEXURE

NO. COMPANIES EVENT DATE

1 ACC Ltd 29-Jun-112 Ambuja Cements 18-Feb-083 Asian Paints 30-Jun-104 Axis Bank 8-Jun-115 Bajaj Autos 2-Jul-096 Bharat Petroleum 8-Sep-107 Bharti Airtel 24-Jul-098 BHEL 30-Aug-079 Bhushan Steels 8-Sep-11

10 Ceat Ltd 14-Jul-1011 Cipla Ltd 12-Aug-0812 Coal India Ltd 8-Sep-1113 DLF 27-Jul-1114 GAIL 30-Jan-0915 Grasim inds 10-Aug-1016 Gujarat Hotels 15-Jul-1117 HCL 22-Oct-0818 HDFC Bank 10-Jun-1019 Hero Moto Corp 30-Aug-1020 Hindalco Inds 14-Sep-1121 HUL 7-Nov-0722 ICICI Bank 22-Jun-11

59

23 Infosys 26-May-1024 ITC 10-Jun-1125 Jaiprakash Asso 15-Sep-1026 Jindal Steel and Power LTD 13-Sep-1027 Kotak Mahindra 30-Jun-1028 Larsen n Tourbo 18-Aug-0929 Lupin ltd 20-Jul-0930 Mahindra n Mahindra 3-Jul-0831 Maruti suzuki Ltd 14-Aug-0832 NTPC Ltd 8-Sep-1133 ONGC 8-Sep-0834 Power grid corp of India 11-Jan-1035 Punjab National Bank 29-May-0836 Ranbaxy lab 28-Apr-1137 Reliance Inds 10-May-1038 Reliance infrastructure 2-Jul-0939 SBI 20-May-1140 Sesa Goa ltd 30-Jun-1141 Siemens 18-Jan-1142 Sterlite Inds 15-Jul-1143 Sun Pharmaceuticals 21-Aug-0944 Tata Motors 10-Aug-1045 Tata Power co.ltd 2-Aug-1146 Tata steel co 12-Jul-1047 TCS 18-Jun-0848 Ultratech cements 25-Aug-1149 Varun Shipping 28-Jul-1150 WIPRO 29-Jun-11

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No.

Companies Event Date Total Assets(Cr)

No.Of Shares

1 ACC Ltd 29-Jun-11 7703 187,745,3562 Ambuja Cements 18-Feb-08 6636 1,525,617,5113 Asian Paints 30-Jun-10 2039.45 95,919,7794 Axis Bank 8-Jun-11 285627.8 413,203,9525 Bajaj Autos 2-Jul-09 3439.69 289,367,0206 Bharat Petroleum 8-Sep-10 33029.49 361,542,1247 Bharti Airtel 24-Jul-09 41776.12 3,797,530,0968 BHEL 30-Aug-07 10869.39 489,520,0009 Bhushan Steels 8-Sep-11 27595.93 212,358,310

10 Ceat Ltd 14-Jul-10 1404.05 34,243,53411 Cipla Ltd 12-Aug-08 5290.99 802,921,35712 Coal India Ltd 8-Sep-11 20738.29 6,316,364,40013 DLF 27-Jul-11 26471.67 1,698,385,71914 GAIL 30-Jan-09 18279.38 1,268,477,40015 Grasim inds 10-Aug-10 8947.49 91,698,77816 Gujarat Hotels 15-Jul-11 15.62 3,787,51517 HCL 22-Oct-08 4001.97 679,998,59218 HDFC Bank 10-Jun-10 277352.6 465,225,68419 Hero Moto Corp 30-Aug-10 4447.22 19968750020 Hindalco Inds 14-Sep-11 46604.38 191454230821 HUL 7-Nov-07 1527.76 218211980222 ICICI Bank 22-Jun-11 473647.1 115271444223 Infosys 26-May-10 24501 57415155924 ITC 10-Jun-11 18870.98 781842430025 Jaiprakash Asso 15-Sep-10 30930.41 212643318226 Jindal Steel and Power LTD 13-Sep-10 20804.01 934269031

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27 Kotak Mahindra 30-Jun-10 50850.66 73687150428 Larsen n Tourbo 18-Aug-09 25112.47 60780500929 Lupin ltd 20-Jul-09 3437.36 44590205030 Mahindra n Mahindra 3-Jul-08 18.34 59658707531 Maruti suzuki Ltd 14-Aug-08 10043.8 28891006032 NTPC Ltd 8-Sep-11 120629.5 824546440033 ONGC 8-Sep-08 94771.12 213887253034 Power grid corp of India 11-Jan-10 62092.11 420884123035 Punjab National Bank 29-May-08 246918.6 31530250036 Ranbaxy lab 28-Apr-11 6258.36 42203169037 Reliance Inds 10-May-10 218937 327337400838 Reliance infrastructure 2-Jul-09 19267.09 24487026239 SBI 20-May-11 1335519 67104483840 Sesa Goa ltd 30-Jun-11 16512.32 86910142341 Siemens 18-Jan-11 3962.6 34029490042 Sterlite Inds 15-Jul-11 30067.61 336120753443 Sun Pharmaceuticals 21-Aug-09 5747.47 103558195544 Tata Motors 10-Aug-10 35912.05 53827228445 Tata Power co.ltd 2-Aug-11 20954.12 237307236046 Tata steel co 12-Jul-10 76745.77 95921445047 TCS 18-Jun-08 13486.62 195722099648 Ultratech cements 25-Aug-11 16667.95 27406530149 Varun Shipping 28-Jul-11 3522.82 15000777350 WIPRO 29-Jun-11 29595.7 2,458,756,228

Analysis:

From the above analysis, it is seen that Bharti Airtel have highest total assets among all

the fifty companies and Grasim industries has the smallest total assets.

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