Understanding a behaviour of dividend payout policy in vietnam from various financial models

UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
THE NETHERLANDS

VIETNAM - NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

UNDERSTANDING A BEHAVIOUR OF DIVIDEND PAYOUT POLICY
IN VIETNAM FROM VARIOUS FINANCIAL MODELS

BY

DANG HUU LOC

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, MARCH 2015


UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
THE NETHERLANDS

VIETNAM - NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

UNDERSTANDING A BEHAVIOUR OF DIVIDEND PAYOUT POLICY
IN VIETNAM FROM VARIOUS FINANCIAL MODELS

A thesis submitted in partial fulfilment of the requirements for the degree of
MASTER OF ARTS IN DEVELOPMENT ECONOMICS

BY

DANG HUU LOC

Academic Supervisor:
Dr. VO HONG DUC

HO CHI MINH CITY, MARCH 2015


ACKNOWLEDGEMENTS
I could not finish this thesis without assistance, guidance, and encouragement of people
surrounding me. Therefore, I would like to express my appreciation to those contributions.
First and foremost, I would like to acknowledge my academic supervisor, Dr. Võ Hồng
Đức, for his guidance, encouragement and useful recommendations during the time of
implementing this study.
Besides my supervisor, I would like to express a deep gratitude to all the lecturers at the
Vietnam – Netherlands Program. Especially, I am grateful to Assoc. Prof. Dr. Nguyễn Trọng
Hoài, Dr. Phạm Khánh Nam and Dr. Trương Đặng Thụy who facilitate me to finish my research.
I would like to thank my friends for their helps during the courses as well as in the thesis
writing process.

Last but not the least; I am indebted to my parents: Đặng Thanh Liêm and Nguyễn Thị
Ngoan, who always love unconditionally and support me spiritually every time I need.

HCMC, March 2015
Đặng Hữu Lộc


ABBREVIATIONS
FE

Fixed effect

GLS

Generalized least square

MM

Miller and Modigiliani

Model 1

The partial adjustment model

Model 2

The Partial adjustment model under an adaptive expectations hypothesis

Model 3

The partial adjustment model under a rational expectations hypothesis

Model 4

The earnings trend model

OLS

Ordinary least squares

PCSE

Panel corrected standard errors

RE

Random effect

SOA

Speed of adjustment


ABSTRACT
This study is conducted to examine and understand a behavior of dividend payout policy at
Vietnam’s listed firms for the period from 2007 to 2013. In doing so, the four well known
models are adopted, known as: (i) the partial adjustment model, (ii) the partial adjustment model
under an adaptive expectations hypothesis (the Waud model), (iii) the partial adjustment model
under a rational expectations hypothesis, and (iv) the earnings trend model. Each of the models is
briefly summarized below for the convenience of the readers.

The first model considers the dividend behavior as a partially adjustable process to the
target dividend. The current profit will mainly determine the target dividend through constant
desired payout ratio. This model is to provide some evidences in terms of the reluctance in
changing dividend and the speed of dividend adjustment. The institutional ownership variable is
also embedded into the model to investigate its impact on dividend policies. However, it was
argued that the target dividend should be explained mainly by the long-run expected earnings
instead of current earnings (Harkins and Walsh, 1971). The adaptive expectations model is
employed to determine the long-run expected earnings. This expectation bases on the hypothesis
that human can learn from the past experience and apply for life. Accordingly, the model which
is integrated by both partial adjustment (Model 1) and adaptive expectation explains better
dividend policies (Lee et al., 1987). This new model is also called as the Waud model and known
as Model 2 in this study. Through this model, the responsibility of managers to change dividend
as well as the relationship between the institutional shareholders and dividends are tested.
Robert Lucas and Thomas Sargen, criticized that the adaptive expectations hypothesis
adopted in Model 2 is unrealistic because it purely bases on the past experiences and disregards
available information to managements. Therefore, they propagated a hypothesis which is known
as rational expectations. This hypothesis states that managers are rational to optimize their
forecasts which are incorporated current values and available information into the process of
forming expectations. The partial adjustment (Model 1) and rational expectations to consider two
dividend characteristics as the Waud model, to be known as Model 3.
As the last model attempted in this study, Model 4, the earning generating process is
assumed to follow a random walk with trend. This assumption is consistent with the view from
Fama and Babiak. Accordingly, any change in the dividend payout policy will include two parts:


(i) the first part is from full adjustment of the expected change of earnings; and (ii) the second
part is from partial adjustment of the remainder of earnings. This model is known as Model 4 in
this study.
The three hypotheses have been developed and tested in this empirical study, one of its
first kind in Vietnam: (i) Firms are more reluctant to decrease the dividend than to increase the

dividend; (ii) The speed of adjustment in dividends for Vietnam market is very flexible and
higher than for developed markets such as Australia, Austria, Germany, Sweden, and United
Kingdom; and (iii) the absence of institutional ownership reduces significantly dividends.
Key findings in this empirical study reveal that three above hypotheses are plausible in the
case of Vietnam. First, the empirical results reveal that managers are more afraid of cutting
dividends than raising dividends. Second, the listed firms in Vietnam are very flexible to change
the dividend policies. Third, the absence of institutional shareholders in the firms will
significantly decrease the level of dividend payouts. Fourth, the findings also confirm that the
adaptive expectations hypothesis is more appropriate than the rational expectations hypothesis in
explaining the dividend behavior for the emerging markets, in particular for Vietnam, regardless
of the presence or absence of the institutional ownership in a firm.


Contents
CHAPTER 1: ................................................................................................................................................ 1
INTRODUCTION ........................................................................................................................................ 1
1.1.

Problem statement ......................................................................................................................... 1

1.2.

Research objectives ....................................................................................................................... 2

1.3

The structure of study ................................................................................................................... 3

CHAPTER 2 ................................................................................................................................................. 4
LITERATURE REVIEW ............................................................................................................................. 4

2.1

Dividend and characteristics ......................................................................................................... 4

2.2

Dividend theory ............................................................................................................................ 7

2.3

Institutional ownership.................................................................................................................. 9

2.4

The relationship between dividend policy and institutional ownership ........................................ 9

2.4.1

Taxation .............................................................................................................................. 10

2.4.2

Agency theory ..................................................................................................................... 11

2.4.3

Signaling ............................................................................................................................. 12

2.4.4

Summary of empirical evidence ......................................................................................... 14

CHAPTER 3 ............................................................................................................................................... 15
RESEARCH METHODOLOGY ................................................................................................................ 15
3.1

The partial adjustment model ...................................................................................................... 15

3.2

The Partial adjustment model under an adaptive expectations hypothesis (The Waud model) .. 17

3.3

The partial adjustment model under a rational expectations hypothesis ..................................... 19

3.4

The earnings trend model (ETM)................................................................................................ 21

3.5

Hypotheses development ............................................................................................................ 22

CHAPTER 4 ............................................................................................................................................... 24
SAMPLE, VARIABLES AND ECONOMETRIC ANALYSES ............................................................... 24
4.1

Sample selection ......................................................................................................................... 24

4.2

Variables ..................................................................................................................................... 24

4.2.1

Dividend per share .............................................................................................................. 25

4.2.2

Earnings .............................................................................................................................. 25

4.2.3

Institutional ownership........................................................................................................ 25

4.3

Econometric Analyses................................................................................................................. 25

CHAPTER 5: .............................................................................................................................................. 30


DATA DESCRIPTIONS AND RESULTS ................................................................................................ 30
5.1

Data descriptions ......................................................................................................................... 30

5.2

Results ......................................................................................................................................... 33

CHAPTER 6: .............................................................................................................................................. 37
CONCLUSIONS AND IMPLICATIONS .................................................................................................. 37
6.1

A brief summary of the four models adopted ............................................................................. 37

6.2

Conclusions ................................................................................................................................. 38

6.3

Implications................................................................................................................................. 39

6.4

Limitations .................................................................................................................................. 39

APPENDIX ................................................................................................................................................. 46


CHAPTER 1:
INTRODUCTION
1.1. Problem statement
The first stock market in Vietnam was established in Ho Chi Minh City in 2000. Initially,
there were only two companies listed: Refrigeration Electrical Engineering Joint Stock
Corporation (REE) and Saigon Cable and Telecommunication Material Joint Stock Company
(SAM), with a small market capitalization of 270 billion VND. It has been quiet in the Vietnam

Stock market for a long time. However, the stock market was really booming in 2006 on all three
trading floors: Ho Chi Minh City Stock Exchange (HOSE), Ha Noi Stock Exchange (HNX) and
the Over-The-Counter market (OTC). So far, there are 760 listed firms with the market
capitalization of 52 billion USD. In fact, the capitalization of the Vietnam stock market reaches
32% GDP of Vietnam in 2014. Listed firms play a more and more important role in the
Vietnamese economy. As such, it is important to understand key characteristics of listed
companies in Vietnam, in which decisions to pay dividend have attracted attention from
academics and practitioners.
From an interdisciplinary perspective, dividend policy has long been captivating
economists as the major puzzle of corporate finance, so a great deal of effort has been spent on
unraveling this subject. A well-known theorem introduced by Modigliani and Miller (1961)
argued that dividend policy is irrelevant to value of a firm. This view is considered under the
assumptions of a perfect market. However, practice always deviates from the theory due to the
existence of market imperfections such as taxes, transaction costs, agency problem, and
information asymmetry. To assess the influence of dividends in Germany, Amihud & Murgia
(1997) considered a sample of 200 German firms to conclude that dividend change play a
significant role in future prospects of firms. The reason is that a change in payout may provide
information about management’s confidence in the future and so affect the stock price (Breadley,
Myers & Allen, 2011, p.397). In the case of the Austrian firms, dividend also has a negative
correlation with investment (Gugler, 2003). Although there are still many controversies
surrounding this issue, no one can deny that dividend policy has been considered as one of the
most crucial decisions in corporate financial management.

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Dividend payout policy is even more important in the emerging market and Vietnam
market is one of them. Due to asymmetric information, changes in dividend were considered as a
signal about the company’s prospects in the future (Short, 2002). Especially, it influences
substantially shareholders who often plan and expect stable future cash flows for retirees,

pension funds and insurance companies. In fact, on January 20th 2014, Decision No4/2014 was
promulgated to approve the establishment of Voluntary Pension Fund. This decision will pave
the way for vibrant fund market in near future. In relation to asset valuation, multiple models
forecasting stock price in the long run is based on dividend. The models present a necessity to
understand why companies practice and change dividend policies. Moreover, the highly
profitable companies that do not pay dividends usually get the backlash from shareholders.
Therefore, it is necessary to understand dividend behavior for the Vietnam market in this study.
The development of stock market has also associated with the development of the
institutional investors. Institutional investors play an important role not only in corporate control
but also in creating liquidity for the market. Smith (1996) argued that the institutional
shareholders are the resource of monitoring management and lead to changes of governance
structures and performance were targeted. At the end of 2013, the institutions invested
approximately 5 billion USD into the Vietnam stock market. Moreover, 86% listed firms in 2013
was in existences of institutions owning 5% or more of equity in a company. Thus, it is stated
that institutional investors affect significantly the policies of firms, including dividend policies,
but there are not any researches to address how institutional shareholders influence on this policy
in the case of Vietnam. For this reason, this study discusses the relationship between dividends
and institutional ownership from the period of 2007-2013.
1.2.

Research objectives
This study is conducted to meet the following two research objectives.


First, this study aims at examining and quantifying two major characteristics of
dividends in Vietnam using the Partial Adjustment model.



Second, the hypothesis that whether the absence of institutional ownership reduces

the dividend is examined. Four models are applied to test this hypothesis. All data are
collected from listed firms of the Vietnam stock exchange for the period of 20072013.
2


1.3

The structure of study
There are six chapters in this study. First, the introduction chapter presents the problem

statement as well as the research objectives. The second chapter presents the overall literature
relevant to the issues mentioned in the introduction. Chapter 3 demonstrates clearly why four
models are employed to test the hypotheses in this study. Measurements of all variables and
econometric analyses are proposed in the fourth chapter. Based on the discussion in the previous
chapters, Chapter 5 presents the findings drawn from the regression results of the four models.
Finally, conclusions, implications and limitations are presented in Chapter 6.

3


CHAPTER 2
LITERATURE REVIEW
This chapter will introduce a concept and common characteristics of dividends. Then,
views on the dividend policies can be classified into two distinct theories: (i) dividend
irrelevance theory and (ii) dividend relevance theory. Afterwards, the definition of institutional
ownership as well as its effects on dividend policies is examined. This relationship will be
clarified through: taxation, agency theory and signaling. At the end, overall impacts of
institutional ownership on dividends will be summarized to provide final conclusions.
2.1

Dividend and characteristics
According to Frankfurter et al. (2003), dividend is a portion of earnings which a firm

distributes to shareholders in proportion to their ownership. Companies usually pay dividend
annually or quarterly in the form of cash. This payout results in a reduction in cash items and
retained earnings on balance sheet of a firm. Therefore, dividend policy refers to the financial
policy, in which the management decides size and pattern of dividend to distribute among the
shareholders (Lease et al., 2000).
By surveying the opinions of managers, Lintner (1956), Baker and Powell (1999), Brav et
al. (2005) provided evidences to determine the characteristics of dividend policy in which the
theoretical and empirical researches are not sufficient to explain. Although there is the amount of
debate around dividend problem, the financial economists almost agree with the most following
common properties of dividends:

4


Figure 2.1:
1)

The result of Brav et al.’s survey in 2005

First, firms are more reluctant to decrease the dividend than to increase the dividend. A
reason under the information asymmetry hypothesis states that outside investors cannot
access to more information of the company as managers, so dividends are considered as a
good indicators to reveal the firm’s future prospects (Bhattacharya, 1979; John and
Williams, 1985). Accurately, a higher dividend announcement predicts higher current or
future earnings. Many researches show that the return which exceeds expectations usually
follows a positive change of dividends (Pettit, 1972; Asquith and Mullins, 1983). Hence, a
decision of cutting dividends may be a bad news for investors, so it can cause falls in stock

price. For this reason, decreasing dividends is more costly than increasing dividends.

2)

Second, managers restrict to make the decision of changing in dividend that can be
possibly reversed within a short time, so most of companies adjust partially to the target
dividends within each year. Changing gradually dividends is considered as a buffer against
the uncertainty of the future earnings which affect negatively to dividend policy. In other
words, firms usually smooth their dividend. However, the extent of dividend smoothing is
different between developing countries and developed countries. A popular approach to

5


measure the dividend smoothing is an application of the partial adjustment model to
estimate the speed of adjustment (SOA). A research of Javakhadze et al. (2014) in the
period of 1999 to 2011 shows that SOA in developed countries is less than in developing
countries. In detail, the averaged SOAs of developed countries such as Australia, Austria,
Germany, Sweden, United Kingdom equal 0.4557, 0.3578, 0.3306, 0.4962, 0.2303,
respectively. Meanwhile, its values in developing countries including China, Nigeria,
Pakistan, and South Africa, in turn, are 0.6030, 0.5332, 0.6273, and 0.6740. According to
Glen et al. (1995), the volatility of dividends is less concerned in emerging markets than
developed markets. In other words, the signaling in dividend is less important in
developing countries. Hence, the SOAs in emerging markets can be higher than in
developed markets.
An empirical research of Adaoglu (2000) from the Istanbul Stock Exchange argued
that stable dividend policies are not adopted in listed firms. The reasons’ Chemmanur et al.
(2010) suggest that in developing countries, much of listed firms are still small, have
greater growth opportunities and are financially constrained; therefore, they have a higher
cost to pay dividend than to retain earnings. Simultaneously, the dividend policies are also

influenced by volatilities in Vietnam economy in this period, including both of external
effects and internal effects. First, financial crisis in 2007-08 and European debt crisis in
2010-12 affect seriously the Vietnam export and reduce the economic growth. Second,
high inflations come in 2007, 2008, 2010 and 2011, combining the tight monetary policies
in 2011 and 2012. Hence, many companies concentrated to overcome the difficulties rather
than to maintain a stable dividend policies. The role of dividends which acts as signaling
device is omitted. Managements adjust simply dividends in proportion to profits.
Generally, the firms are predicted to adjust quickly their current dividend to the target
dividends for the case of Vietnam in period from 2007 to 2013. In this study, I will also
reinvestigate that whether SOA in Vietnam is more flexible and higher than other
developed countries as mentioned above.

6


Developed countries

Number of firms

Mean

Median

Australia

76

0.4557

0.4372

Austria

6

0.3578

0.3122

Germany

25

0.3306

0.3119

Sweden

31

0.4962

0.4410

United Kingdom

240

0.2846

0.2303

China

11

0.6030

0.5315

Nigeria

5

0.5332

0.6631

Pakistan

17

0.6273

0.6046

south Africa

16

0.6740

0.6343

Developing countries

Table 2.1:

2.2

The result of Javakhadze et al. in 2014

Dividend theory
In recent years, the dividend policy is considered one of the major financial decisions in

listed companies. However, some argued that the dividend policy has no effect on value of a
company. “To pay or not to pay” is always a stumper not only for managers but also for
economists. Due to these contradictory results from various empirical studies, Breadley and
Myers (2002) stated that dividend policy is one of the most complex puzzles in finance. Views
on the topic can be classified into two distinct theories: (i) dividend irrelevance theory and (ii)
dividend relevance theory.
In 1961, the publication (hereafter MM theory) of two noble laureates, Miller and
Modigiliani, laid the foundation of the irrelevance theory. Under the assumption of perfect
capital market, they argued that the market value is only maximized by an optimal investment
policy, not by dividend policy. Specifically, it is assumed that there are two identical firms
except for financial structure, the first financed totally by equity, the second financed by the
mixture of equity and debt. MM theory inferred that the values of the two firms are equal in spite
of the difference in financial policies. From the investor’s perspective, the way which firms
distribute profits does not affect to the earnings maximization of shareholders. For example,

7


when a firm pays out all profits to shareholders as dividends, the stock price will be decreased
equally by the amount of a dividend per share on the ex-dividend date. As a supplement,
Brennan (1971) suggested the rejection of MM theory is synonymous with the rejection of
symmetric market rationality as well as independence of irrelevance information. To support
empirical evidence, Black and Scholes (1974) tested the effect of dividend yield on stock prices,
based on the data of listed firms on the New York Stock Exchange (NYSE). They concluded that
changes in firm value are independent of changes in dividend payout. “The intuitive argument in
favor of the hypothesis is that if management could increase the market value of the firm's stock
by changing dividend policy, why has it not done so already” (Glen et al., 1995, p.3).
Subsequently, there are more empirical evidences in support of MM theory (Miller & Scholes,
1978; Hess, 1981; Miller, 1986; Bernstein, 1996).
On the other hand, firms which do not pay out dividends receive negative reactions from
shareholders. In fact, the dividends are not always reflected completely into the stock price.
When the market is depressed or appreciated, the stock price will be undervalued or overvalued,
respectively. Simultaneously, long-run investors usually require dividends as regular expenses.
Therefore, the regardless of taxes and the unrealistic assumption of efficient capital markets are
controversial in an aspect of applying the rules in the facts. By embodying in taxes, signaling
information, agency cost and human behavior, the economists have proved the opposite. Some
empirical studies reveal that an increasing dividend payment will result in an increase of firm
value (Gordon& Shapiro, 1956; Lintner, 1962; Walter, 1963). Theoretical background of this
argument is the intensity of preference of dividend today over possible shares or dividend
tomorrow. In other words, most of people prefer “a bird in the hand” to “two birds in the bush”.
Moreover, a higher dividend conveys a credible signal of good future prospects, which appeal to
investors willing to pay higher stock price.
Another issue is very noticeable that the existence of tax and differences in tax rate may
distort the dividend decisions. The tax effect hypothesis stated that if dividend tax is higher than

capital gains tax, management will respond by decreasing the dividend payout to ensure that a
shareholder wealth is maximized. In this case, decreasing dividend payout may increase the
value of a firm. Brennan (1970) constructed a model to illustrate this theory. This model was
subsequently extended by Litzenberger and Ramaswamy in 1979. Finally, under agency theory,
paying higher dividend leads to lower agency cost, so company performances will be improved.
8


In summary, although the assumptions in MM theory are difficult to be met in the real
world, it is still referred and studied in many universities. It is crucial since this theorem
mentioned determinants of optimal capital structure and their effects on this structure. Many
empirical studies have been implemented in this topic. However, in an emerging market like
Vietnam, lacking empirical studies of this subject require researchers to pay more attention.

2.3

Institutional ownership
In 1976, Jensen and Meckling defined the ownership structure as the capital allocation of a

company among debt, inside equity held by the management and outside equity. There are also
many different definitions formulated in later studies. The most widely used definition in
relation to the institutional ownership is that “the ownership structure is defined by the
distribution of equity with regard to votes and capital but also by the identity of the equity
owners” (Sivathaasan, 2013, p.1). To facilitate researches, many economists and institutions
proposed different classifications of ownership structure.
According to Morten Balling (1997), ownership structure is classified into seven sectors,
including: (1) central bank and other supervisory authority, (2) the government; (3) banks and
other financial institutions; (4) institutions such as pension fund; (5) individuals; (6) nonfinancial companies; and (7) foreign holdings. However, in this study, we only concentrate to the
institutional ownership which reflects the organizations, companies, funds holding 5% or more
of equity in a company. The benchmark 5% of equity owner was used in accordance with the

regulations of Vietnam government on information disclosure of listed companies. It is argued
that due to the large percentage they hold in ownership structure, institutions are more capable of
affecting to the company’s decisions, including dividend policy, rather than individual investors.
The procedure formulating the relationship between dividend policy and institutional ownership
is described as follows.

2.4

The relationship between dividend policy and institutional ownership
Dividend policy and ownership structure of a firm have been considered as one of the most

crucial and debatable relationship in finance for a number of years. The relationship between
them was recognized from 1964 by Williamson. Afterward, many researchers (Leland and Pyle,
9


1977; Jensen, 1986) have been attempted to establish literatures on this relationship. Short et al.
(2002) argued that institutional ownership creates the incentive to increase the dividends, and it
is the first time that this relationship is investigated in Vietnam. In particular, dividend policy is
influenced by institutional ownership through three mechanisms, including: taxation, agency
theory and signaling. These mechanisms will clarify why the institutional ownership is the cause
to maintain the high dividend. Each of these mechanisms is discussed in turn below.

2.4.1 Taxation
Tax system can distort behaviors of investors when the tax rates on dividend are different
from the tax rates on capital gain. In the United State of America, the government has regulated
that the tax imposed on dividend is separate with income tax of corporations on their profits.
This means that in dividend paying companies, the shareholders was taxed twice, the first in term
of corporation tax on firm’s profits and the second in term of income tax on dividend receipt. As
a result, taxpayers are favorable of the incomes retaining policies rather than the high dividend

paying policies and tax-exempt shareholders is neutral in respect of dividend policies. This leads
the questions “why do firms pay dividend” in Black’s study (1976). In contrast, the tax system in
Vietnam is very different from the U.S. Circular No.128/2003/TT-BTC regulated that the tax
rates of capital gain and dividend are 28% and 0%, respectively. Thereafter, Vietnam’s corporate
income tax law introduced on June 2008 set up the tax rate 25% on capital gains and the tax rate
0% on dividend receipts. Therefore, if institutions are large shareholders in companies, to
maximize their wealth, they will have a propensity of putting pressure on managements to pay
higher dividends.
Another issue to be addressed is “the need of institutional shareholders for funds on an
ongoing basis” (Short et al., 2002, p.108). More precisely, institutions rely not only on capitals
gains but also on dividend to fund their activities such as paying insurance, funding pension.
Furthermore, in developed countries such as the US and the UK, pension funds which manage
trillions of dollars to invest in many stocks, is always the most influential on the market. These
institutions usually pay pensions from investment income rather than from new contributions.
Institutions usually are long-run investors, so they need dividends to pay regular expenses. Thus,
they usually require a stability of dividends to match their liabilities as planned. These
10


requirements may force companies to pay higher dividends than the managers intended,
especially in circumstances of recession and low income. In spite of lack of pension fund in
Vietnam now, this aspect need pay more attention. Since on January 20th 2014, Decision
No4/2014 was promulgated to approve the establishment of Voluntary Pension Fund, the
discussion above will be the foundation of researches in the future.
In short, on the ground of this consideration, it is feasible to suggest that there are a
positive relationship between institutional shareholdings and dividend payout. In other words,
firm with an absence of institutional ownership is lower dividend than others. In future, the need
of maintaining the cash flow of new pension funds in Vietnam will consolidate this hypothesis
stronger unless there are changes in financial policies.
2.4.2 Agency theory

In corporate finance, the agency problem arises when there are interest conflicts between
managers of a firm and shareholders of the firm (Jensen and Meckling, 1976). Managers are
employed to administer firms in accordance with maximizing shareholder wealth. Nevertheless,
managers sometimes act in their own best interests that differ from the best interests of the
shareholders. This leads a necessary monitoring to alleviate losses that managers can abuse from
their positions.
Shleifer and Vishny (1986) argued that large shareholders as institutions have more
incentive than small ownership to monitor the management. In addition, they also have more
voting power and ability to implement the monitoring effectively. However, the free rider
problem may eliminate the incentive of institutions to offer a direct supervision because they
must bear expenses alone. Accordingly to Maug (1998), this problem will be not serious in more
liquid market, since investors can be compensated for the monitoring cost as a consequence of
informed trading. Nevertheless, an emerging market like Vietnam is less liquid, and an event that
institutional shareholders sale a large portion of their equity depresses such stock prices. Hence,
Easterbrook (1984) implied that a method to solve this problem is an increase in dividend payout
to suppress excessive retention of cash flow. Assuming that the firms continue their projects as
planned, they must borrow from the capital market to meet the demand. To obtain loan approval,
they are subject to the monitoring of external financial institutions, for this reason, agency costs
will be reduced.
11


Rozeff (1982) constructed a model in which two market imperfections, agency costs and
transaction costs, were combined to illustrate the dividend payout ratios, and known as the cost
minimization model. The implemented empirical study based on the data of 1000 firms in 64
industries over the period 1974-1980; and agency costs and transaction costs were represented by
five variables in which two proxies of agency costs are significantly negative with dividend
ratios. In other words, this research supported strongly the hypothesis that increased dividends
lower agency costs. Motivating for this view, Lloyd et al., (1985) replicated and expanded the
Rozeff’s cost minimization model by adding firm size as the important variable. The result

strengthened the Rozeff’s hypothesis in introducing agency costs as a major determinant of
dividend payout ratios. Subsequently, this result also was reaffirmed in many studies such as
Schooley and Barney (1994), Moh’d et al. (1995).
Moreover, excessive retention of cash flow may be diverted by managers for wasteful
expenditures or unprofitable project. More precisely, a scarcity of resources promotes managers
to think deeply in spending money. Therefore, La Porta et al. (2000) suggested that increasing
dividend is a good device to protect investors in unprotected legal environments, avoiding the
loss of assets to shareholders.
In summary, instead of self-monitoring, outside institutional shareholders usually have a
propensity to force managers paying higher dividend, and reduced agency cost is the major
incentive. By the way, it is also argued that there is a positive correlation between the higher
dividend and presence of institutional under the view of the agency theory.

2.4.3 Signaling
Signaling theory was firstly addressed in Lintner’s study (1956) and was supported later
by Miller and Modigiliani (1961). They argued that managers usually adopt a stabilization of
dividend policies with long-run payout ratios, so the changes in dividend are perceived as the
changes in the views of managers about future earnings of firms. Precisely, Miller and Rock
(1985) concluded that a higher dividend is a good indicator in relation to the company’s better
prospects. Zeckhauser and Pound (1990) stated that both dividends and institutional shareholders
are good proxies for signaling devices. Therefore, the effect of institutional ownership can crowd
out the effect of dividends as a credible signal to investors. Under this hypothesis, the
12


relationship between dividend and institutional ownership is negative. However, Short et al.
(2002) stated that it is not clearly to explain how stock purchase plans of institutions can convey
a signal of the firm’s future earnings to the market. They proposed two possibilities. First, some
investors expect that the presence of institutions can reduce the agency cost due to their
monitoring activities. However, as mentioned above, since the free rider problem arises,

institutions will adopt higher dividend policy instead of providing freely direct monitoring.
Second, an argument is that institutional investors are more professional than retail investors in
the ability to evaluate the company outlook. Thus the firm which is invested by large institutions
is guaranteed implicitly for a good profitability in the future. Although this hypothesis holds
some attractions, they suggested that there is not much strong evidence to support this scenario
which portfolio of institutions is more profitable than individuals.
Fama and French (2001) pointed out that given firm characteristics, the proportion of
listed firms paying cash dividend is in a fall propensity from 1978. To explain the “disappearing
dividend phenomena”, Amihud and Li (2006) stated that the decline in the information content
of dividends causes the decreasing of paying dividends which have been used as a credible signal
to market. The reason is the existence of institutional investors which are more informed than
retail investors. The informational asymmetry problems between institutional investors and retail
investors are derived from two reasons. First, given amount of information, institutions gain
more profit, so they have more incentives to gather information. Second, their proficiency can
help them reduce marginal cost in collecting and processing information. It is obvious that they
also have more financial powers which are manipulated to acquire information. “Since the more
informed institutional investors use their information in trading stocks, by the time a dividend
change is announced, part of the information that it conveys about the firm’s value is already
incorporated in the stock price” ( Amihud and Li, 2006, p.646). In other words, the increasing of
holdings by institutions is the reason for the decline in the information content of dividend,
leading lower dividend payout.
However, all studies were implemented in developed countries, these references to
appropriate with an emerging market is still an open question. In Vietnam, the magnitude of the
market is still small, less liquidity and not transparent, so large institutions can abuse their
market power to manipulate stocks, not basing on the evaluation of the future prospect of the
firms. Accurately, they can convey a wrong signal to the market. Therefore, the opinion that the
13


role of institutional shareholders is likely a good signaling is more controversial in the case of

Vietnam.

2.4.4 Summary of empirical evidence
Overall, the effect of institutions in dividend decisions is formulated through three ways.
The sum of tax, agency cost and signaling considerations determines the property of this
relationship (negative, positive or not significant). Under the view of tax effect, to maximize the
wealth and to match the liabilities are the clear incentives of the institutions to demand a high
dividend. Under the view of agency theory, paying out dividend is a good approach not only to
reduce agency cost but also to avoid the free rider problem. Moreover, a high dividend policy
restricts the excess of free cash flow to be used for wasteful expenditure. In contrast, the
relationship between institutional ownership and dividend under signaling hypothesis is
ambiguous, and there are not strong evidences in emerging markets like Vietnam. Therefore, a
positive association between the high dividend and institutional ownership is predicted, and this
is the first times this hypothesis is investigated in the case of Vietnam. To support to this
hypothesis, in the case of Canada, Eckbo and Verma (1994) proved that dividend is proportional
to the voting power of institutional ownership and inversely proportional to the voting power of
managerial ownership. Short et al. (2002) revealed the strong evidence that institutional
ownership affect significantly to payout ratios from the sample of the U.K listed firms.

14


CHAPTER 3
RESEARCH METHODOLOGY
Every market has different characteristics, so many models were employed to test the
hypotheses more accuracy. There are four models adopted in my study, including: (i) the Partial
Adjustment model, (ii) the Partial adjustment model under an adaptive expectations
hypothesis(the Waud model), (iii) The partial adjustment model under a rational expectations
hypothesis, and (iv) the Earnings Trend Model. To test the hypothesis, a dummy variable which
describes the absence of the institutional ownership is added in four models. If the absence of an

institution owning 5% or more of equity appears, it will be equal 1 and 0 otherwise.
Subsequently, the hypothesis development and expected sign table will be represented at the end
of this chapter.

3.1

The partial adjustment model
Lintner (1956) proposed firstly a dividend model, basing on the positive dividend-earnings

relationship. From available information of 600 U.S listed, he selected carefully 28 companies to
interview for detailed investigation. Although dividend policy is significantly different across
companies, some common patterns were withdrawn from his result. These are clarified as
follows:
-

Managers almost believe that the target payout ratio should be remained with a little
deviation in long-run.

-

In making dividend decision, managers pay attention to the change in the existing payout,
not to the amount of dividend level.

-

Earnings are the major factor to dominate the dividend policy better than other factors.

-

Managers restrict to make the decision of changing in dividend that can be possibly

reversed within a short time. Therefore, most of companies adjust partially to the target
dividends within each year, and the speed of adjustment should be done a certain way.
Based on these characteristics, Lintner (1956) established a dividend behavior model,

named partial adjustment model. For a given year t with firm i, there is a desired payout ratio r
between the target dividends, D∗ ti , and the profit Eti:
15


D∗ ti = rEti

(1)

Firms adjust partially annual dividends to the target dividends, so a new equation is as
below:
Dti - D(t−1)i= a + b (D∗ ti-D(t−1)i ) + uti

(2)

where a = a constant, and b is a coefficient representing the speed of adjustment of the
actual dividends to the target dividends in a year. The reduction of net profits leads to decrease
the target dividends and put pressure on cutting current dividend. However, the current dividends
can be not reduced if the constant in the function (2) is positive. If the constant is negative, the
current dividends can be cut even earnings increasing. Therefore, the intercept reveals the
reluctant of the firm to decrease or increase the dividend. According to Lintner, the firms adjust
partially dividends year by year, so the speed is subject to 0reduced form becomes:
Dti - D(t−1)i = a + brEti - bD(t−1)i + uti

(3)

Brittain (1966), Fama and Babiak (1968) indicated that equation (3) explains well in
predictions of dividend with small mean squared error. Furthermore, all variables in this equation
are significant, and the R2 does not increase significantly when financial variables are embedded.
Similarly, other kinds of economic behaviors, especially supply response and inventory
investment, are characterized by the partial adjustment process, so this model was modified to
employ in numerous empirical studies (Nerlove, 1958; Hill, 1971; Burrows and Godfrey, 1973).
As discussed in the literature review, institutional ownership have significant effects on making
dividend decisions, and this is reflected in my model by transforming the desired payout ratio ri
as follows:
D∗ ti= rEti+ ri Eti Ins

(4)

where:


Ins:

A dummy variable describes the presence or absence of the institutional

ownership.
Substituting (4) into (2), the model becomes:
Dti - D(t−1)i = a + brEti + bri EtiIns - bD(t−1)i + uti

(5)

According to the theory, the coefficient (b𝑟𝑖 ) is predicted to be negative. If constant term is
positive, it implies that managers are more reluctant to decrease than to increase dividend.
16

3.2

The Partial adjustment model under an adaptive expectations hypothesis (The Waud
model)
Although the model proposed by Lintner is very useful to determine the dividend of firms,

the formation of the target dividends is unlikely to be sufficiently described. Harkins and Walsh
(1971) suggested that the long-run expected earnings are more important than current earnings in
dividend decision by most managers. By the way, the expected dividends D∗ ti are related to the
long-run expected earnings Eti∗, instead of current earnings Eti, by a ratio r
D∗ ti=rEti∗

(6)

Through the long-run expected earnings, the target dividends are determined not only by
current dividend but also by other factors such as past experiments or relevant information in
outlining expectations. In other words, managers can rely on the reaction of shareholders in the
past or permanent prospect of the firm to decide further increase or decrease. A method to model
the expectation is popularized by Cagan (1956) and Friedman (1957), in which “economic agents
will adapt their expectations in the light of past experience and that in particular they will learn
from their mistakes” (Shaw, 1984, p.25). According to this hypothesis, the equation of
expectations is formed:
∗
∗
Eti∗- E(t−1)i
= c (Eti–E(t−1)i
)

(7)

where c is the adjustment speed of expectations, such that 0≤ c ≤1.
Equation (7) is called as adaptive expectation or error learning hypothesis. More detailed,
modified expectations in each period are proportional to a fraction c of the difference between
the current earnings and previous expected earnings. If c=1, Eti∗ = Eti, implying that current
earnings are perceived totally to transfer to long-run expected earnings. On the contrary, if c=0,
∗
Eti∗=E(t−1)i
, managers believe that long-run expectations are not influenced by the current

earnings. It provided a simple way to model an expectation basing on the belief that human
usually is dominated by habit persistence and study from their experiences. By doing repeated
algebra, the equation (7) is transformed as:
Eti∗ = cEti + c(1-c)E(t−1)i + c(1 − 𝑐)2 E(t−2)i + c(1 − 𝑐)3 E(t−3)i +…..

(8)

The above equation reinforces the adaptive expectation in meaning that more distant events
are less influential than more recent events. It also represents that the expectations are
accumulated data from previous years. In 1968, Roger N. Waud combined two models, the
17