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INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS

AUGUST 2013
VOL 5, NO 4

THE RELATIONSHIP BETWEEN DIVIDEND PAYOUTS RATIO AND FUTURE EARNINGS GROWTH, A CASE OF LISTED COMPANY IN IRAN MARKET HoseinParsian (Corresponding author) Young Researchers and Elite Club, Torbat-e-Jam Branch, Islamic Azad University, Torbat-e-Jam, Iran Amir Shams Koloukhi Young Researchers and Elite Club, Torbat-e-Jam Branch, Islamic Azad University, Torbat-e-Jam, Iran SaeedAbdolnejad University of Economic Science, faculty of Financial Science, MA Student Abstract Decision making about dividend payout is one of the most important decision that companies should encounter with. Companies dividend payouts over the time and with a stable manner can effects on share price, future earnings growth and finally investor's evaluation about owners' equity. This study examines the use of the payout ratio as a predictor of a firms future earnings growth. OLS (ordinary least squares) employed for hypothesis test in multi variables regression method. We found out there is a positive relation between dividend payouts and future earnings growth by analyzing 102 companies over the 2004-2010 period. These findings are consistent with Arnott and Asness (2003) research results that document a positive relation between dividend payouts and future earnings growth.In other words, dividend payouts is one of the most important items in forecasting future earnings growth of companies listed in Tehran stock exchange. KEY WORD: FORECASTING (PREDICTING) FUTURE PROFIT GROWTH, TEHRAN EXCHANGE STOCK 1. Introduction Dividend payout is such an important subject that has been given increased attention by finance researchers and still has remained as a Controversial issue in financial management. one of the major issues is recognition of effective elements on dividend payouts ratio. Investment opportunities that can affect on future earnings are one of those elements. On the other hand dividend payouts have a leading role in the value of the firm and owners equity evaluation. Arnott and Asness (2003) researches revealed the unexpected result that higher dividend payouts ratio at the market level corresponds to higher future earnings growth in American stock exchange. However according to Miller and Modigliani (1961) dividend irrelevance theorem a lower dividend payouts ratio was assumed to be associated with higher future growth and thus higher future equity returns.Higher future equity returns. Because if a firm pays out a lower proportion of its retained earnings as dividends the firm has greater retained earnings ratio which help the company to undertake future profitable investment opportunities resulting in a higher growth rate of earnings. However it is crystal clear that a stable dividend over the time has a positive relation with future earnings growth. We are about to examine the relevance between dividends payouts ratio and future earnings growth in listed firms on Tehran stock exchange because of the high importance of it. This remainder of this paper is organized as follows. Section 2 offers a review of prior literature; Section3 provides an overview of the data and methodology. In Section 4 we present Research hypothesisANDour results. Concluding comments are provided in Section 5. 2. LITERATURE REVIEW Decision making about the dividend payouts is one of the most important subjects that a company encounters with. Dividend payouts policy is one of the elements that affects on the firm value. Payouts are known by its cohesion characteristic so the companies with lower dividend payouts ratio will face the decrease in their values. So managers tend to pay less profit unless they are sure about their capability of maintaining dividend payouts in a high level. Dividend payouts policy lead to companys going concern and maximize shareholders wealth and has a direct effects on shareholders expectation, cash in hand, financing method, financial structure and companys going concern. Being accustomed with the methods of dividend

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INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS

AUGUST 2013
VOL 5, NO 4

payouts and awareness of the effects of this ratio over companys financial situation and its short term and long term activities will improve dividend payouts effectiveness and efficiency. Dividend payouts ratio is dependent on lots of elements such as: investing opportunities profitability, income tax, laws obligation and liquidity. It means because of extra amount of cash flow and low need to liquidity, investing opportunities profitability decrease, so company increase the dividend payouts and because of low amount of cash in comparison to investing opportunities, decrease the amount of dividend payouts(Ferdinand and Gull 1999) .

Lintner (1956) by talking to companies managers has done one of the oldest researches about dividend payouts
methods. He understood that investors are looking forward to taking significant proportion of companies earnings and concluded that stability in dividend payouts is really important. According to Miller and Modigliani (1961) hypothesis a negative relation between dividend payouts ratio and future earnings growth is expected. This was because as a firm pays out a lower proportion of its retained earnings as dividend, retained earnings ratio will increase which help company face with profitable investment opportunities that leads to a higher growth rate of earnings. Pruitt and Gitman (1991 ) concluded that the most important elements in a companys divid end payouts policy are current and last year profit, earnings flexibility and growth by examining 1000 of biggest companies in the united states. Baker and Powell (2000) researched about managers points of view over effective elements on dividend payouts by emailing questionnaires to 603 companies listed in New York stock exchange with various types of activities. They mentioned 20 items on their questionnaires and sum it up that current and next year expected earnings are the most important elements in relation to dividend payouts policy and after that dividend payouts behavior can be really noticeable. Arnott and Asness (2003) found a positive relation between dividend payouts and future earnings growth during their studies among American companies since 1871 to 2001.although they understood that according to life cycle hypothesis, there is a strong negative relation between dividend payouts ratio and internal investing level. Gwilym and company (2006) researches in 10 countries just consistent withArnott and Asnessresults. Parker (2005) indicated that there is a strong positive relation between dividend payouts and earnings growth across America, Canada and Australia by his research in these countries market during 1956 to 2005. The strength of this relation was weaker in Australia than 2 other countries. Vivan (2006) proved Arnott and asness hypothesis too and found it by examining 20 industries in England. Ping and Roland (2006) just indicated the positive relation between dividend payouts ratio and future earnings growth. 3. Methodology & data 3.1 Analysis pattern Descriptive statistics, Pierson correlation and regression are used for analyzing data. This research is a correlation type. Methods for determining of pooling or paneling data, F Limer test is basically used. H0 of this test is based on pooling data and in H1 used panel data methods. Data which is used in this paper is adopted from audited financial statements. So the major parts of data are provided from Rahavardnovin and Tadbirpardaz software's and the rest of that from Tehran stock exchange data base. Eviews 7th version is used for statistical assessment. 3.2 Statistic population and sample All of the companies listed in Tehran stock exchange are included in this research and sample is chosen by elimination method and although companies are chosen which have below qualification: 1. Are listed in Tehran stock exchange before 2004 2. Their financial statements for years 2004 to 2010 are available. 3. There has not been any pause in their activities during the years which were mentioned in above 4. -For increasing the comparison capability their fiscal year should be March 19 th 5. -Investing companies and brokers are not chosen because the border between their operational and financial activities is not clear.

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INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS

AUGUST 2013
VOL 5, NO 4

Considering above items and small population size, 102 companies and 714 observations are chosen as sample for each variable. Although for ensuring that results are distributable to all of the companies listed in Tehran stock exchange for the years 2004 to 2010 sample quantity is calculated base on below formula:

Where: N: total sample size ,n: subsample size , p: primary probability(success) ratio , q:failure ratio , z:normal distribution standard variable , : estimate error Estimated error () is equal to 12% in this paper and on the other hand primary estimate (p=q=0.5) for proving the hypothesis resulted from observation is 0.5. Since 463 companies are listed in Tehran stock exchange, sample is comparable by this formula:

N = 463, p =0.5, p =0.5, z/2= z.25 =1.96 , = 12%

So this is clear that for 95% assurance level and 12% error, 58 samples should be chosen and since 102 companies are used, the results are distributable to all of the companies listed in Tehran stock exchange (2004-2010) 3.3 Research hypothesis H0: there is not a positive and significant relation between dividend payouts and future earnings growth of companies listed in Tehran stock exchange. H1: there is a positive and significant relation between dividend payouts and future earnings growth of companies listed in Tehran stock exchange. 3.4 variablesdefinition TABLE 1: VARIABLES DEFINITION SYMBOL Definition

LEV ROA EG

Leverage. This study follows Ping and Ruland (2006) and calculates leverage ( 0 LEV ) as a firms book value of debt ( 0 BVD ) divided by the firms total assets ( 0 TA ) Return on assets calculated by dividing earnings to companys total assets. Earnings growth calculated as follow: , Past earnings growth is measured as below: Dividend payouts ratio that is calculated by dividing divided earnings to reported annual earnings

PEG

Payouts Size E/P

Firm size. In accordance with other studies such as Fama and French (2002), Ping and Ruland (2006), firm size is calculated as the natural logarithm (ln) of the firm's market value of equity earnings per share that is calculated by dividing companys annual profit to owners equity

This table provides summary definitions of the variables employed in the regression analysis

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3.5 Result of hypothesis test Generally panel data method is used in researches because of special reasons such as: increase in observations quantity and the degree of freedom on one hand and decreasing heteroskedastic and colinearity on the other hand and F Limer used.Hypothesis are as follow: H0: intercept parameters are equal in all segments H1: intercept parameters are not equal in all segments Test statistic is defined as below by the use of RRSS (restricted residual sum of squares) resulted from OLS and URSS (unrestricted residual sum of squares) result from regression:

RRSS URSS N 1 F F( N 1, NT N K ) URSS NT N K

In F test, H0 hypothesis, equality of intercepts (pooling data method) is against H1 hypothesis, non equality of intercepts (paneling data method) .So if H0 reject, therefore paneling data method is accepted.F Limer test results for observation are presented below:

Comparing statistic amounts resulted from F limer test with the amounts from table 2 we can conclude that H0 is accepted. In other word OLS is a proper manner for assessing the research hypothesis. Table 2 consists of data descriptive statistic. It is clear that sum of the average and standard deviation is in permissible area for all of the data. Pierson correlation coefficient among independent variables is mentioned in table 3. TABLE 2: DESCRIPTIVE STATISTIC OF VARIABLES

PEG mean median max min Standard deviation Total observation 1.1139 1.3615 1.9314 -1.7627 0.8139 714

LEV 67.5165 68.25 208.35 6.19 20.2687 714

E/P -0.027 0.3494 4.4602 -312.4167 11.776 714

ROA 14.2613 12.25 70.01 -31.75 14.2868 714

SIZE 11.5786 11.478 16.8113 2.485 1.4759 714

EG 1.0043 1.3513 2.4992 -1.8406 0.9388 714

PAYOUT 0.0341 0.0141 3.1303 -0.7879 0.1396 714

This table provide summary of descriptive statistic of variables

TABLE 3: Pierson correlation coefficient among independent variables LEV E/P ROA SIZE EG -0.0316 0.0296 0.0088 -0.0325 -0.2003 0.0683 -0.0113 0.2343 -0.0163 1 0.1941 -0.4412 0.0099 1 -0.0163 -0.0083 -0.0125 1 0.0099 0.2343 -0.0956 1 -0.0125 -0.4412 -0.0112 1 -0.0956 -0.0083 0.1941 0.0683

PAYOUT 1 -0.2003 -0.0325 0.0088 0.0296 -0.0316

PAYOUT EG SIZE ROA E/P LEV

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INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS

AUGUST 2013
VOL 5, NO 4

4. Research hypothesis andresults: There is a positive and significant relation between dividend payouts and future earnings growth for companies listed in Tehran stock exchange. Results from hypothesis assessment are illustrated in table 4:

TABLE4: RESULTS OF HYPOTHESIS ANALYSIS

Significance level
0.0000 0.0741 0.0001 0.0212 0.0000 0.0000 0.0000 , Adjusted 0.0000

statistic

Coefficients

variables

8.6082 1.7885 3.8172 2.3101 22.3498 -5.6256 -8.7851 , Durbin-Watson: 1.98

1.1032 0.2711 0.0342 0.0033 0.0055 -0.0070 -0.0689 , F limer test: 5.2030 ,

E/P

Probability:

As presented in table 4, 4.27% of companies future earnings growth change is adjusted by independent variable and adjusted coefficient of determination is 3.49% considering population and sample size. The effect of fixed amount on companies future earnings growth is 1.1032, positive and significant, effect of dividend payouts independent variable is 0.2711(payouts independent variable effect on future earnings growth), positive and in 10% level significant (positive and 10% Significant level), the effect of firm size independent variable is 0.0342, positive and significant, the effect of ROA is 0.0033, positive and in 5% level significant, the effect of p/e is 0.0055, positive and significant, the effect of LEV is -0.0070, negative and significant, the effect of PEG is -0.0689, negative and significant. Durbin-watson is 1.98 that means there is no significant correlation between error details and they are independent. F limer test is equal to 5.2030 in regression model that in accordance to significance level in the table (0.0000), it was observed that generally regression is significant so H0 hypothesis wasrejected. Comparing the real and estimate model are shown in belowgraph:
1,200 800 400 600 400 -400 200 0 -200 -400 0

1 - 83 4 - 85 7 - 87 11 - 83 14 - 86 17 - 88 21 - 85 24 - 87 28 - 84 31 - 86 34 - 88 38 - 84 41 - 86 44 - 88 48 - 84 51 - 86 55 - 83 58 - 85 61 - 88 65 - 84 68 - 86 71 - 88 75 - 84 78 - 86 81 - 88 85 - 84 88 - 86 92 - 85 95 - 88 99 - 84 102 - 86
Res idual Actual Fitted

Results of This graph indicate that the model has a high level of explanatory ability

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INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS

AUGUST 2013
VOL 5, NO 4

5. Conclusion Decision making about dividend payout is one of the most important decision that companies should encounter with. Companies dividend payouts during the time and with a stable manner effects on share price, future earnings growth and finally investors evaluation about owners' equity. Therefore the relation between dividend payouts and future earnings growth of companies listed in Tehran stock exchangeare chosen in this paper.OLS(ordinary least square)has been used for hypothesis assessment. Empirical results from 2010 year show that there is a positive and significant relation between dividend payout ratio and companies future earnings. In other word dividend payouts is one of the most important items in forecasting future earnings growth of companies listed in Tehran stock exchange. This results are the same with Arnott and Asness (2003) in USA, Parker (2005) in USA, Canada and Australia, vivan (2006),Gunlim and company (2006) in 10 countries and Ping and Roland (2006)that said there is a positive and significant relation between dividend payouts and companies future earnings growthbut differs from Miller and Midigliani (1961) result which indicate that there is a negative relation between dividend payouts and companies future earnings growth because they thought that if a firm pays out a lower proportion of its retained earnings as dividends the firm has greater retained earnings ratio which help the company to undertake future profitable investment opportunities resulting in a higher growth rate of earnings.

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INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS

AUGUST 2013
VOL 5, NO 4

References 1- Arnott, R., and Asness, C. (2003), Surprise! Higher Dividends = Higher Earnings Growth. Financial Analysts Journal, 59, 70-87. 2- Baker, H. K. and Powell, G. E. (2000), Determinants of Corporate Dividend Policy: A Survey of NYSE Firms, Financial Practice and Education, Spring/Summer, pp. 29-40. 3- Chan, L., Karceski, J., and Lakonishok, J. (2003), The level and persistence of growth rates. Journal of Finance, 58, 643-84. 4- Fama, E. F., and French, K. R. (2000), Forecasting Profitability and Earnings. The Journal of Business, 73, 161-175. 5- Ferdinand A. Gull (1999), Analysis of joint effects of Review of investment opportunity set, free cash flow and size on corporate debt policy, quantitative finance and accounting. 6- Flint, A., Tan, A., Tian,G. (2010), Predicting Future Earnings Growth: A test of the Dividend Payout Ratio in the Australian Market. The International Journal of Business and Finance Research, http://ssrn.com/abstract=1667076 7- Gwilym, O., Seaton, J., Suddason, K., and Thomas, S. (2006), International Evidence on the Payout Ratio, Earnings, Dividends, and Returns. Financial Analysts Journal, 62, 36-53. 8- Lintner J. (1956), Distribution of Incomes of Corporations among Dividends Retained Earnings and Taxes, American Economic Review, Vol.46, pp. 97-113. 9- McAndrews, J. J., and Nakamura, L. I. (1992), Entry-Deterring Debt. Journal of Money, Credit and Banking, 24, 98-110. 10- Miller, M. H., and Modigliani, F. (1961), Dividend policy, growth, and the valuation of shares. Journal of Business, 34, 411433. 11- Parker, K. C., (2005), Do higher dividends lead to higher earnings growth? Working Paper, Simon Fraser University. 12- Ping, Z., and Ruland, P. (2006), Dividend Payout and Future Earnings Growth. Financial Analysts Journal, 62, 58-69. 13- Pruitt, S. W. and Gitman, l. J. (1991), The Interactions between the Investment, Financing, and Dividend Decisions of Major U.S. Firms, Financial Review, Vol. 26, pp. 409-430. 14- Vivian, A. (2006). The Payout Ratio, Earnings Growth Returns: UK Industry Evidence. Working Paper, School of Economics, Finance and Business, of University Durham.

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