DETERMINANTS OF DIVIDEND PAYOUT RATIOS-A STUDY OF INDIAN INFORMATION TECHNOLOGY SECTOR

Abstract
Profitability has always been considered as a primary indicator of dividend payout ratio. There are numerous other factors other than profitability also that affect dividend decisions of an organization namely cash flows, corporate tax, sales growth and market to book value ratio. Available literature suggests that dividend payout ratio is positively related to profits, cash flows and it has inverse relationship with corporate taxes, sales growth and market to book value ratio. This paper is an attempt to empirically analyze the determinants of dividend payout ratio of Indian Information Technology sector. The paper also focuses on identifying whether various factors available as per literature influence dividend payout ratio in IT sector in India in existing scenario or not. Statistical techniques of correlation and regression have been used to explore the relationship between key variables. Thus, the main theme of this study is to identify the various factors that influence the dividend payout policy decisions of IT firms in India.

Introduction
Dividend payout has been an issue of interest in financial literature. Academicians & researchers have developed many theoretical models describing the factors that managers should consider when making dividend policy decisions. By dividend policy, we mean the payout policy that managers follow in deciding the size and pattern of cash distribution to shareholders over time. In seminal paper, Miller and Modigliani (M&M) (1961) argue that given perfect capital markets, the dividend decision does not affect the firm value and is, therefore, irrelevant. Most financial practitioners and many academics greeted this conclusion with surprise because the conventional wisdom at the time suggested that a properly managed dividend policy had an impact on share prices and shareholder wealth. Since the M& M study, other researchers have relaxed the assumption of perfect capital markets and offered theories about how dividend affects the firm value and how managers should formulate dividend policy decisions. Over time, the number of factors identified in the literature as being important to be considered in making dividend decisions increased substantially. Thus, extensive studies were done to find out various factors affecting dividend payout ratio of a firm. The setting of corporate dividend policy remains a controversial issue and involves ocean deep judgment by decision makers. There has been emerging consensus that there is no single explanation of dividends. Previous empirical studies have focused mainly on developed economies. The undertaken study examines the relationship between determinants of dividend payout ratios from the context of developing

country like India. The study looks at the issue from emerging markets perspective by focusing specifically on Indian Information Technology sector. The primary objective of this study is to find out whether several factors as per available literature influence the dividend payout ratio of Indian Information Technology sector.

Backdrop of Indian Information Technology Industry

The Indian IT industry has a prominent global presence today and has emerged as the fastest growing segment of the Indian industry both in terms of production and exports. Information technology industry in India is one of the fastest growing industries. Indian IT sector has built up valuable brand equity for itself in the global markets. IT has a major role in strengthening the economic and technical foundations in India. The sector can be classified into 4 broad categories- IT services, Engineering services, ITES- BPO services, E business. The origin of IT sector can be traced to 1974, when mainframe manufacture, Burroughs, asked its India s sales agent, Tata Consultancy services to export programmers for installing system software for a U.S. client. The IT industry originated under un favourable conditions. Local markets were absent and government policy towards private enterprises was hostile. During that time Indian economy was state controlled and the state remained hostile to software industry through the 1970s Government policy towards IT sector changed when Rajiv Gandhi became prime minister in 1984.His new computer policy consisted of recognition of software exports as a delicensed industry, permission of foreign firms to set up wholly owned, export- dedicated units and a project to set up a chain of software park that would offer infrastructure below market costs. These polices laid the foundation for the development of a world class IT industry in India. The profile of the industry has changed considerably since then. Today, Indian IT companies such as TCS, Wipro, Infosys, and HCL etc. are renowned in the global markets for their IT prowess. Some of the major factors which played a key role in Indias appearance as key global IT players include escalating number of skilled professionals in IT, vast academic infrastructure of India. India has second leading English speaking work force in the world. The cost of software development and other services in India is very competitive as compared to west. Indian IT industry has also gained enormously from the availability of a robust infrastructure (telecom, power and roads) in the country. Incentives such as income tax holiday until 2010 have been provided for the export of IT enabled services. Over the past decade, information technology industry has become one of the fastest growing industries in India. Strong demand over past few years has placed IT markets in the Asia Pacific region. The Indian software and ITES industry has grown at a CAGR of 28 % during last five years. It is expected that the contribution of IT and ITES to national GDP will rise to 7 % by 2007-08 against 4.8% in 2005-06. The Government of India projects an export of US $ 50 billion by the year 2008 for the Indian software industry.

Along with the growth opportunities, IT sector is one of the highest paying sectors. The average augment in salary in IT sector across the levels was around 16%.The recruitment of engineers and IT professionals in their industry is growing at the compound annual rate of 14.5 % approximately. According to National Association of software and services Company (NASSCOM), the Indian IT software and services sector grew by 31.4%during 2005-06, notching up aggregate revenues of US $ 29.6 billion, up from US $22.5 billion in 2004-05. Encouraged by the 2005-2006 performance, The IT and ITES sector is confident of achieving the US $60 billion in exports by 2010. Thus, it is evident that the information technology sector in India has grown leaps and bounds in last five years. Consequently the financial performance of IT sector has surged in terms of revenue, profitability and shareholders wealth maximization. .India is ahead of competitors such as Singapore, Hong Kong, China, Philippines, Mexico, Ireland, Australia and Holland, among others Therefore, it would be an attention-grabbing task to study how the dividend distribution pattern of this sector has changed and various factors influencing the DP ratio of the sunshine sector of the Indian economy.

Literature Review
Researchers have proposed many different theories about the factors that influence a firms dividend policy .A number of factors have been identified in previous empirical studies to influence the dividend policy decisions of the firm. To, enumerate few profitability, risk, cash flows, agency cost, growth, taxes, price earnings ratio etc. The liquidity or cash flows position is also an important determinant of dividend payouts. A poor liquidity position means less generous dividends due to shortage of cash. Studies reveal that dividend payments depend more on cash flows, which reflect the companys ability to pay dividends, than on current earnings, which are less heavily influenced by accounting practices. They claim current earnings do no really reflect the firms ability to pay dividends

Key Variables that Affect the Dividend Payout Ratio of a Firm

As per available literature following factors have been identified that affect the dividend policy decisions of the firm. Enumerated below are the key variable along with the relationship with dividend payout ratio of the firm.

Information Technology (IT) industry has played a major role in the Indian economy during the last few years. A number of large, profitable Indian companies today belong to the IT sector and a great deal of investment interest is now focused on the IT sector. Over the past decade, IT has become one of the fastest growing industries in India. It has grown at a CAGR of 28% during last five years. IT sector has been chosen for study because it is a sunshine sector of India. It currently accounts for almost 7% of Indias GDP. It will account for 15 % of Indias GDP by 2012. In order to have a good benchmark of the Indian IT sector, IISL (India Index services and Product Ltd.) As developed the CNX IT sector index which provides investors and market intermediaries with an appropriate benchmark that captures the performance of the IT segment of the market. The sample selected for study consists of all the companies, which are constituents of CNX IT index of NSE (list attached to the annexure). Companies in this index are those that have more than50% of their turnover from IT related activities like software development, hardware manufacture, vending, support and maintenance. The sample companies amount to a major chunk of IT sector revenue and occupies a dominant position in terms of market share. The average total traded value for the last six months of CNX IT Index stocks is approximately 91% of the traded value of the IT sector. CNX IT Index stocks represent about 96% of the total market capitalization of the IT sector as on March 31, 2005. The period under study is 2000-2006.As it is known that period of 5 to 6 years covers 2 business cycles. That is why period chosen is 2000-2006, which covers both recessionary and booming phase of IT, industry. The data has been sourced from Prowess database of CMIE. Hinduja TMT Ltd and I-Gate Global Solutions Ltd. have been excluded from our analysis due to non- availability of data. The variables that have been identified can be stated as follows: Y= dividend payout ratio X1=earnings before interest and taxes /total assets X2= cash from operations (Rs. crore) X3=corporate tax /profit before tax X4=annual sales growth X5= Market to book value ratio

The statistical techniques of correlation and regression were used to explore the relationship between these variables.

Empirical Analysis
The dividend payout (Y) was used as dependent variable and other variables (x1, x2, x3, x4, x5) were used as independent variables. On this basis under mentioned multiple linear regression equation was developed. Y= +b1x1+b2x2+b3x3+b4x4+b5x5 Where, is the regression constant and b1, b2, b3, b4 and b5 are regression coefficients respectively. The regression coefficient indicates the amount of change in the value of dependent variable for a unit change in independent variable.r2 the coefficient of determination, gives an estimate of the proportion of variance of dependent variable accounted for by the independent variable. It suggests the covariance between changes in dividend rate and earnings rate. The value of r2 varies between 0 and 1.An r2 of zero means that the predictor accounts for none of the variability of Y by X . An r2 of 1 means perfect prediction of y by x and that 100% of variability of Y is accounted for by X. The higher the value of r2, the closer is the relationship between the variables.

Correlation Matrix
The first step was to construct correlation matrix for various possible combinations of dependent and independent variables. The outcome of this exercise was the understated correlation matrix.

The correlation matrix highlighted that there is significant correlation between two variables i.e. Y and X2.It is apparent from the correlation matrix there is weak correlation between other variables. To get a better picture of the relationship among the key variables regression analysis was also performed.

Regression Results
Regression Results of Empirical Model

Regression Coefficients and their Significance

ANOVA Results

The regression results confirmed results which were obtained from correlation matrix. The results depicted only one of the key variable i.e. cash from operations

have significant regression coefficient at 5 % level of significance. Also, the same variable has significant correlation with Y as is evident from correlation matrix. A deeper look at the R2 value reveals that the existing model only explains 27 % of the dividend payment pattern of Indian IT sector since it assumes a value of 0.273 The F value is found to be significant at 5 % level of significance suggesting overall applicability of the existing model. The regression results indicate positive but insignificant relationship between profitability and dividend payout ratio. This result highlights the fact that though profit has a positive relationship with profitability is not an important determinant of dividend payment pattern in IT sector. The results of the study show positive and significant association between cash flows and dividend payout ratios. Thus, liquidity is an important determinant of dividend payout ratio their by indicating that a good liquidity position increases firms ability to pay dividend. Generally, firms with good and stable cash flows are able to pay dividends easily compared to firms with unstable cash flows. The results disclose insignificant relationship with corporate taxes, sales growth and MTBV ratio. This clearly indicates that these are not important factors that influence the dividend payment behaviour of firms in IT sector.

Relationship between DP Ratio and Stock Beta

Year to year variability in earnings has been regarded as one of important factors influencing dividend payout of an organization. By and large, a company with volatile earnings has lower dividend payout as compared to a company with stable earnings. In present study beta or systematic risk has been taken as proxy for representing volatility of earnings. Beta numerically can assume three values i.e. =1, >1, <1.Companies with >1 are considered to be high risk company. For understanding the association between beta and DP ratio, the initial step was to calculate the beta for all the constituent companies of CNX IT index for each of the 7 years. Beta coefficients are slope of the regression line relating the return on market with return on specific stock. The market return was taken as an independent variable and individual stock return as dependent variable. Daily closing values of CNX IT index was taken as market return and adjusted daily closing prices were taken to symbolize stock returns. Share price are adjusted when there is change in face value of the scrip or the company makes a bonus issue or right issue or if there is any stock split .With the aid of these values following linear regression equation was developed for each of company Y= + x Where, Y= adjusted daily closing price of a stock = regression constant (risk free rate of return) = beta or systematic risk x= adjusted daily closing share prices Subsequent to the computation of beta, again simple linear regression analysis was conducted to investigate whether unpredictability in earnings as represented by beta is one of the determinants of dividend payout ratio in Indian IT sector or not. Table V portrays the relationship between beta and DP ratio. The analysis of the table shows that beta is a significant determinant.

Regression results

Conclusion
This study examines the determinants of dividend payout ratios of CNX IT listed companies in India. It can be concluded that existing variables as per available literature do not explain the dividend payment pattern of IT sector. Only liquidity and beta (year to year variability in earnings) is found to be a noteworthy determinant. The period undertaken for study i.e. 2000-2006 covers both recessionary and booming phase of Indian information technology sector. Till 2003, there was recession and from 2003 onwards IT sector witnessed exponential growth. After 2006 linear growth was seen in IT sector. This sector is now, steadily approaching towards maturity. The Return on equity of this sector is very high compared to other sectors of Indian economy. Before 2003 the profitability of the IT firms was scanty and consequently this sector was at the bottom of the list in terms of dividend payment. The average payout of the IT sector during this period was 21.53%.This can be attributed two factors .Firstly, the industry presented immense growth opportunities for the companies hence the managers were of opinion that they can provide the investors better returns if they plough back the earnings into business. Secondly, most firms in Industry were facing volatile earnings stream which deterred them from paying more dividends. After 2003, there was a substantial spurt in dividend payout ratios of the IT companies. Infosys Technologies, Wipro Technologies, HCL Technologies were among the highest dividend paying companies. Infosys Technologies paid as high dividend as 2590% in the year 2004.This surge in dividend can be attributed to high profitability and subsequently high liquidity of IT companies. IT sector is a human intensive sector and do not require huge capital asset base like manufacturing companies for their operations. The major asset of this sector is manpower. Therefore the funds required for recruitment and retention of manpower is comparatively less than funds required for purchasing capital assets. So these firms can easily release funds for payment of dividends. Thus, it can be concluded that IT firms in India have high liquidity and it is an important determinant of dividend payout ratio. Since the profitability of the companies is also very high so even if there is year to year variability in the earnings of the firms they can easily pay huge dividends. Since the existing variables explain just 27% of Indian Information technology dividend behaviour future research can be focused on discovering

variables that explain the remaining 70% of the behaviour. Examining the influence of price earnings ratio, debt equity ratio on dividend payout policy would be an interesting exercise.

Reference:

International Research Journal of Finance and Economics- Kanwal Anil Jaypee Business School, Noida, India Sujata Kapoor Institute of Management Studies, Ghaziabad, India The corporate dividend saving decisions", Journal of Financial and Quantitative Analysis, Vol.7 No.2 Lease, Roanald C., Kose John, Avner Kalay, Uri Loewenstein, and Oded H Sarig, Dividend Policy: Its Impact on Firms value, (Harvard Business School Press)