Dividend Policy and Financial Performance of Money Deposit Banks in Nigeria

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Dividend policy is a central and often debated issue in modern corporate finance. Despite decades of research, scholars have not reached a consensus on whether dividend payments influence a firm’s value. As noted by Fischer Black (1976), “the harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don’t fit together.” Consequently, this unresolved question has driven numerous theoretical and empirical studies attempting to explain why firms choose to pay or withhold dividends. According to Brealey and Myers (2003), dividend policy remains one of the top ten unresolved issues in finance.

A dividend represents a distribution of earnings to shareholders. Moreover, dividend decisions form one of the four key areas of financial management, alongside financing, investment, and working capital management decisions (Ross et al., 2002). Firms must carefully decide what portion of earnings to distribute to shareholders as dividends and what portion to retain for reinvestment. Therefore, the process of deciding dividend versus retained earnings constitutes the essence of dividend policy.

Dividend policy refers to management’s long-term plan for allocating cash flows between reinvestment in the business and distribution to shareholders. In addition, Irandoost (2013) emphasizes that the ultimate goal is to maximize shareholder wealth. Dividend decisions can also signal a firm’s financial health, thereby affecting investor perception and share prices (Masum, 2014).

Scholars remain divided on the relevance of dividend policy. For instance, Miller and Modigliani (1961) argue that dividend policy is irrelevant in a perfect market, having no effect on stock prices or the cost of capital. Conversely, Walter (1956) and Gordon (1963) contend that dividends convey positive information that can raise stock prices. On the other hand, Pettit (1972) suggests that dividend payments may reduce stock prices and overall firm value.

Furthermore, dividend policy communicates the firm’s performance to stakeholders. Swee et al. (2007) assert that investment decisions determine future earnings and potential dividends, while dividend policy influences the cost of capital. Hence, financial managers must balance reinvestment with dividend payments to ensure equity among shareholders (Ibenta, 2005). Ultimately, the ability of a bank to pay dividends largely depends on its financial performance.

1.2 Statement of the Problem

Formulating an effective dividend policy is challenging for directors and financial managers because investors have differing preferences for current dividends versus future capital gains. The complexity of dividend decisions lies in balancing shareholder expectations with the firm’s growth needs (Mohammed, 2007).

Dividend policies influence stock prices since investors often prefer immediate dividends over potential future gains. The “bird in the hand” theory, proposed by Gordon and Lintner, suggests that dividends in hand are less risky than uncertain future capital gains (Ade, 2006). Empirical studies indicate that firms with higher dividend payout ratios tend to have higher market values because shareholders favor immediate returns (Hermuningsih & Wardani, 2009; Darsono, 2009).

Previous studies have examined factors determining dividend payout ratios, the impact of dividend policies on profitability, and the effects of financial crises on dividend payments. However, most studies (e.g., Yusof & Ismail, 2016; Pandey & Ashvini, 2016; Khan et al., 2016) were conducted in foreign economies. This study fills a gap by investigating dividend policy and financial performance in Nigerian money deposit banks, a context less explored in existing literature.

1.3 Objectives of the Study

The main objective of this research is to assess the impact of dividend policy on the financial performance of money deposit banks in Nigeria. Specific objectives include:

1. To analyze the determinants of dividend policy in Nigerian money deposit banks.

2. To examine the effect of profitability on dividend policy.

3. To determine the relationship between dividend policy and financial performance.

1.4 Research Questions

1. What are the determinants of dividend policy in money deposit banks?

2. How does profitability affect dividend policy in money deposit banks?

3. Is there a significant relationship between dividend policy and financial performance?

1.5 Research Hypothesis

H01: There is no significant relationship between dividend policy and the financial performance of money deposit banks.

1.6 Significance of the Study

This study provides insights into how dividend policies affect the financial performance of banks. It offers a framework for banks to assess dividend mechanisms and optimize profitability. The study benefits financial sector professionals and management teams by providing guidance on designing effective dividend policies.

Additionally, the research contributes to academic literature, complementing prior studies and offering a reference point for future investigations.

1.7 Scope of the Study

The study examines the relationship between dividend policy and financial performance in ten Nigerian money deposit banks. These banks were selected based on data availability and completeness necessary for the research.

1.8 Definition of Terms

• Dividend: A portion of retained earnings paid to shareholders, either in cash or stock, as a reward for investment.

• Dividend Policy: A company’s strategy for deciding between retaining earnings and distributing profits as dividends, considering factors such as legal requirements, industry norms, and shareholder tax brackets.

• Wealth Maximization: Selecting financial decisions that maximize owners’ wealth by increasing the market value of shares.

• Earnings per Share (EPS): Net earnings less preference-share dividends divided by outstanding ordinary shares.

• Shareholders: Equity holders and owners of a company.

• Capital: Funds raised from shareholders and borrowings.

• Dividend Payout Ratio: The percentage of distributable earnings paid to shareholders as dividends.

• Profitability: The firm’s ability to generate returns on invested capital.

• Financial Statement: Formal records of a firm’s financial activities, including the balance sheet, income statement, retained earnings statement, and cash flow statement.

• Performance: The effectiveness with which a firm achieves its objectives.

• Adoption: The act of choosing to use a particular idea or policy.

• Cash Flow: The actual inflow and outflow of cash over a period.

• Stock Exchange Market: A regulated financial market where securities are traded, with prices determined by supply and demand.