3.6.1 Measurement of Variables

The following are the variables to be use in
the study;

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1)
Current dividends (Divt): The current dividend variable refers to total cash dividends
declared in a particular financial year, which is inclusive of interim, final
and any other special cash dividends paid by the company.

2)
Lagged Dividends (Divt-1): This variable is the cash dividends paid by the
company one year prior to the year under consideration. The role of lagged
dividend variable is to demonstrate the desire of management to follow stable
dividend policy. In order to follow a stable dividend policy, management has to
allow the past dividend trend to influence the current dividend payments.

3)
Current Earnings (Et): Current earnings are the company’s total net income in a
particular financial year. Since dividend payout ratio equals dividend divided
by earnings available for common shareholders, this study has naturally
selected the earnings available for common shareholders as earnings variable.
The earnings available to common shareholders are equivalent to earnings after
tax duly adjusted for distribution to minority interest, extraordinary items and
the preference dividends paid to preference shareholders, whenever preference
capital appeared in capital structure.

4) Investment Expenditure : It is
represented by the capital spending per share. The ratio represents the
percentage of total cash flow required for investment needs. As the ratio
increases, firms might reduce dividend payout and satisfy investment
requirements using internally generated funds first. Investment
Opportunity, Companies having high investment opportunities require more money
to finance their future investments, so that they pay fewer dividends and make
more investments to maximize their expected return (Myers & Majluf, 1984).
Therefore, an inverse relationship can be expected between investment
opportunity of the company and dividend policy. We will use market-to book value
ratio as a proxy for the investment opportunity, which is calculated as the
market value of equity divided by the book value of equity.

5) Leverage
Ratio (LEV): The transaction cost theory states that the firms having higher
proportion of debt finance in total capital will have higher level of commitment
to pay the fixed interest charges and this will reduce the dividend payment to
common equity shareholders (Nizar Al?Malkawi, 2007). Therefore, companies having
high financial leverage pay fewer dividends. We will use long-term debt to
capital ratio as a proxy for the leverage ratio and hypothesised an inverse
relationship between the leverage ratio and dividend payout ratio.

6) Free
Cash Flow (FCF): According to agency cost theory the agency problem arises
between the principal owner (shareholders) and agent (manager) when the manager
takes the action for their self-interest without considering benefiting shareholders.
The excess amount of free cash flow available to the manager increases the
agency cost as they are free to use that financial reserves for their
self-interest. In this regard, the payment of dividend to the shareholders
reduces the free cash flow available to managers and the agency problem between
them (Easterbrook, 1984; Jensen & Meckling, 1976; Rozeff, 1982). Therefore,
a positive relationship can be expected between the free cash flow available
for the company and the dividend payout ratio. The free cash flow is measured
as the ratio of the net operating cash flow to the total assets.

7) Firm
Size (SIZE): The larger firms have higher proportion of institutional
shareholdings, and, therefore, they have easy access to capital market, which lead
them to pay higher amount of dividend. Another argument is that the larger the
size of the firm more it would be difficult to monitor the firm, which
increases the agency problem between the managers and the shareholders.
Therefore, larger firms need to pay more dividends in order to reduce the
agency problem. Considering these arguments, we hypothesise a positive
relationship between size of the firm, which is measured as the natural log of
the market capitalisation of the company and the dividend payout ratio.

8) Profitability
(PROF): Lintner (1956) found that the critical factor affecting the dividend
decision of a firm is the net earnings. In another study, Fama and French
(2001) found that the larger and more profitable firms pay more dividends as compared
to smaller and fewer profitable firms as the dividends are paid from the profit
after tax. Therefore, we expect a positive relation between the profitability, which
has been proxied by return on assets and dividend payout ratio. The return on
assets is measured as the ratio between earnings before interest and taxes and
the total assets.

9) Liquidity
(LIQ): It may happen that a firm can have enough profits to declare the
dividends but not sufficient cash in hand to pay the dividends. The payment of
dividend means outflow of cash for a company. Thus, it is expected that the
dividend decision of the firm is affected by the liquidity position of firm.
Higher liquid company can pay higher dividend due to the excess amount of cash.
The current ratio is used to measure the liquidity position of a company, and
it is defined as the ratio of current assets to current liabilities and we
expect a positive relation between the current ratio and dividend payout ratio.

10) Business
risk (BR): The signalling theory suggests information asymmetry always exists
between the insider (managers) and outsiders (shareholders) as the inside
managers have private information about the firm’s current condition and future
prospects which are not known to the outsiders. The managers can convey this
private information to the shareholders in the form of dividend (Bhattacharya,
1979). Thus, dividend acts as a signalling device and managers can receive
incentives for communicating the private information to the outsiders. Business
risk is used as a proxy for the uncertainty in the firm’s current and future
earnings, and it is measured as the standard deviation of first difference of
operating income divided by total assets and we hypothesize a negative
relationship between the business risk and dividend payout ratio.