Liquidity and Size Determine Dividend Policy

A firm’s size and liquidity were seen as the only characteristics that impact dividend policy, according to a study.

There have been numerous studies in the past that have explored the relationship between a firm’s characteristics and its dividend payout ratio (percentage of earnings paid out as dividends). Some of the earlier studies determined that the most important factors influencing dividend policy to be the level of current and expected earnings. Further research examined the effects of investment decisions on dividend policy by analyzing firm size and liquidity, capital adequacy and ownership structure.

A study by Hira Ahmad at the University of Western Ontario built upon these studies and extended the research to publicly traded North American firms over the 30-year period of 1989 through 2019.

Ahmad looked to see which, if any, firm characteristics have any causal relationship to the dividend payout policy and influence a firm’s decisions regarding it. The variables explored in the study were firm size, leverage (total debt to total assets), profitability (net income to total assets), liquidity (free cash flow to total assets) and growth rate (ratio of net investing cash flow) of the firm. The main difference between past studies and this research was the definition of firm size. While some researchers used market capitalization to define the size of a firm, Ahmad used the relative size of total assets as a proxy for size.

The researcher concluded that over time the characteristics of leverage, profitability and growth were not successful in explaining the variation in the dividend payout ratios of firms. However, two notable exceptions produced statistically significant results—the size and liquidity of the firm. These two characteristics explain the variation in the dividend payout ratio of firms that pay dividends. Of the two, liquidity was found to have a meaningful causal relationship to the dividend payout ratio.

Despite the lack of unanimity among past researchers regarding what factors have a causal relationship with dividend policy, this study finds that firm size and liquidity are the most important determinants. The conclusion: Large companies are more likely to pay dividends because these firms often have greater levels of liquidity.

Source: “Determinants of Dividend Policy: A Study About the Impact of Changing Firm Characteristics on Dividend Payout Ratios,” by Hira Ahmad; SSRN, May 2019.