Effects of Dividends on Common Stock Prices: The Nepalese Evidence

Solving the Puzzle of Relative Importance of Dividends and Retained Earnings in Stock Valuation: A Case of Karachi Stock Exchange

“…Another study conducted by Pardhan [9] tried to establish the relationship between dividends, retained earnings and share price in the corporate settings of Nepal. Using pooled data of 29 companies for the period from 1991 to 1999 and running various linear and logarithmic form regressions with and without lagged variables of price earnings ratio and market price to assume firm's effect constant, they assessed the relative importance of dividends and retained earnings in determination of the stock price.…”

“…We follow the methodology of Friend & Pukett [4]. This methodology was also replicated by Kumar & Mohan [17], Pardhan [9], Azhagaiah & Priya [15] and Khan (2009). There is an evidence of this type of empirical investigation in Pakistan as well (Nishat,[18]).…”

“…This problem could be dealt with adding a lagged variable of price earnings ratio in the model as companies of different size, product mix and financial structure should have different risk and higher risk implies that companies should adopt a lower dividend payout policy in a view to deal with future adverse variations in the earnings that might force the firms to cut the dividends, thus high risk would imply both lower payout and lower price earnings ratio and vice versa (Friend and Pukett [4]). Pardhan [9] also proposed that firm effects such like discussed before should be held constant by introducing variable of lagged price earnings ratio as this ratio is an accurate measure of investor assessment of risk and profit prospect arising out of investment opportunity being financed either through internal investment i.e. retained earnings or external debt or equity financing.…”

“…This effect in this way could produce a downward bias towards the retained earnings (Friend and Pukett [4]). Short run changes in income on the other hand, evoke relatively small fluctuation in the respective price (see, Pardhan [9]) so this problem could be solved by adding lag of market price into the equation. So the model equation would be: This is consistent with the price behavior as in Equation (III) price of the company is determined by the previous expectations on the current expectations of the price, dividends and retained earnings (Friend and Pukett [4], Pardhan [9], Khan [16]).…”

“…According to Pardhan [9] high retained earning implies that firm is in growth phrase and has good future prospects. From this point of view we cannot deny the importance of retained earnings.…”