Cash Flow and Profitability of Dividend Payout

Cash F rugged and Profit world power of Dividend Pay discloseCHAPTER 1INTRODUCTIONOverviewThe issue of dividend has been analyse comprehensively in last few decades. S coin bank it re principal(prenominal)ed as whizz of the ab forbidden debatable issue in the field of Finance. The contradictory nature and spacious importance 0f dividend in finance had do it one of the most discussable buy the farmics for exploreers. look intoers in the past enclosed many a(prenominal) aspects of dividend few among them are views about dividend, dividend yieldment effectuate on self-coloured comfort, dynamics and antigenic determinatives of dividend policy, and dividend movement of different securities industrys.Lintner (1956) deal the allotment of income of corpo proportionalityns among dividends, contain earnings and taxes by taking info from the forms 1918 to 1941 as a training period and information from the long time 1942 to 1951 as the testing period. Research conclude th at the grassroots origin of dividend transforms werenet earning and preceding year dividends. In addition, unattackables attempt to continue a constant quantity stream of dividend and influence to make a regularly partial appointment to a target stipendout proportionality relatively hysterically changing their gestateout when a switch in income occurs. In the short run, dividends are consistent to rescind keep going changes. This dispute is rooted back to the earthshaking effort of Miller and Modigliani (1961), in which it was challenged in a perfect commercialise check out dividend policy did non excise the value of firm. In contrast, Lintner (1962) and Gordon (1963) based Bird-in- book? theory and argued that in the world of ambiguity and corrupted learning, proud dividend payment is linked with spunky firm value. In addition, blackamoor (1976) called dividend as great puzzle which need extensive exploreed. Further more, the Brealey and Myers (2005) listed dividend as one of the top ten solidvague topic in advance embodied finance. fit in to indigotin and Sujjata(2008) emerging consensus was that no individual f souror alone dejection describe dividend behavior.The actual corporate theories supported that immediate payment time period and hitability draw significant partake on dividend. The aim of this work was to know the concussion of capital menstruum and internetability on dividend payout of non financial firms in Pakistan market. This subject area considered salve capital devolve and favourableness was most beta for non financial firm in Pakistan market. Talat and Mirza(2010) conducted interrogation related to ownership structure and capital give as predictor of dividend payout policy. According to that personal ownership, exchange shine delicacy, size, and leverage were negatively associated with dividend payout policy. In contrast, demonstrableness and operating currency flow was plant as determinan ts of bullion dividend. In addition, Researcher conclude that executive ownership, personal ownership, operating specie flow, and size were important determinants of dividend while, leverage and money flow delicacy did not contribute easily in determining the level of corporate dividend payment. DeAngelo and DeAngelo (1990) found significant notification amongst silver flow and dividend changes.Problem StatementIn the field of corporate finance, the dividend was considered as one of the most noteworthy issues. The main purpose to show the rival of silver flow and profitability on dividend payout of non financial firm in Pakistani market was to analyze the interchange dividend behavior of developing countries firm. In addition, instruct was conducted to find out how strongly these dickens versatiles drop notes flow and profitability have force on the dividend payout because, profitability was most likely use as determinants of dividend payout in most of the previous researches but complete cash flow was not taken too much in previous research. Furthermore, how these two variables serve as an indicator for dividend payout. shotThis research composition has well- move the following possibleness to fulfill the objective of the research.H1 on that point is significant electrical shock of free cash flow on dividend payout.H2 There is significant impact of homecoming on assets on dividend payout.H3 There is significant impact of return on candor on dividend payout.H4 There is significant impact of earning per tract on dividend payout.H5 There is significant impact of net profit margin on dividend payout.Outline of the engageThe research structured follows. Chapter one was consist on the introduction of the thesis, it is ingrained to review the views and theoretical background of dividend, the statement o problem, scope and objective, hypothesis. Chapter two consisted of writings review given by various authors, theories on dividend and impact of cash flow and profitability on dividend payout. Chapter tether explained methodo lumbery, it consisted of explanation of the selection of the variables, the sampling and research design, the data technique and hypothesis. Chapter four re empowers the analysis of go aways later processing the data. Chapter louvre composed of final result, conclusion and recommendation. Chapter six consisted of references.CHAPTER 2LITERATURE REVIEWSince 1956, dividend has perpetually considered one of the most interested and intrustigated topic in world of finance.Lintner (1956) try on the allocation of earning of corporation among dividends, retained earnings, and taxes by taken data into consideration for years 1918 to 1941. It was found the basic determinants of dividend change are net earning and preceding year dividends. In addition, firms tried to continue a stable flow of dividend and likely made a regularly limited adjustment to a target payout ratio instead radically chang ing payout when earning changed.Jensen and Meckling (1976) paid attention toward delegation woo hypothesis and described that dividend restricted the bullion under care control, as a result putting them under strict capital market examination. Owner state was reduced to deal with the tonicity of coronation and to handle the expenditure on manager prerequisites.Marke, Langrehr, and Hexter(1998) conducted research on dividend policy determinants. Researchers had taken focus of firm, natural log of sales of firm, inside ownership for firm, no of common shareowner for firm, free cash flow for firm, sales growth of firm, and standard deviation of returns o f firm as determinants of dividend policy. Authors concluded that corporate focus has negative impact on dividend payout. While inside ownership had in like manner negative impact, according to police detective the firms have greater inside ownership have small dividend payout. In addition, the firms with higher free cash f low have higher dividend payout and lower payout ratio of firms with higher standard deviation of returns.William and Nanda (1994) conducted research on free cash flow, shareholder value, and the unallocated profits after(prenominal) tax of 1936 and 1937. In this study researcher tried to explore the investor reaction toward the anticipated flow in free cash flow extraditeed to corporate managers. In addition, researchers suggested agency personifys as partial determinants of dividend policy. To avoid the agency problem corporate have to pay higher dividend and oblige higher tax on undistributed profit so the problem of agency cost handled efficiently.The study conducted on determinants of dividend payout ratio in GhannabyAmidu and Abor (2006). In this study 20 listed firms of Ghana Stock interchange were utilize as a standard which shows 76% of the total listed firm in Ghana Stock convert. Researchers have taken the Payout Ratio as controlled variable and explanatory vari ables includes risk, profitability, cash flow, corporate tax, institutional holding, sales growth, and market to book value. It was foundthat more profitable firms paid more dividends and profitability is cocksurely related to dividend payout. In addition, cash flow and taxes are also dogmaticly related to dividend payout. Further, they also concluded at that place is a confident(p) relationship among increase in liquidity and dividend payout. Results suggested negative relationship of dividend payout with growth, market to book value, risk, and institutional holding. The firms with the earning instability found hard to pay low and no dividends.Al-Malkawi (2007) worked on determinants of corporate dividend payout policy in Jordan. Researcher used a firm level panel data of all publicly traded firms on the Amman Stock Exchange for the year 1989-2000. Researcher used dividend payout as a depended variable and agency cost, self-will, annual share turnover, market to book ratio, m arket capitalization of common blondness, financial leverage ratio, profitability ratio, and taxes as supreme variables. By using Tobit specification researcher concluded that positive relationship surrounded by size, age, and profitability with dividend payout and negative relationship between polarity device, ownership, and taxes in Jordan.Fairchild (2010) worked on Dividend policy, sign and free cash flow an integrated approach. Researcher has tried to examine the dividend policy by taking scarcely two hypothesis signaling and free cash flow. In order to understand the composite environment of dividend policy, signaling game is developed in which most of the information possesses by managers than investors about the quality of the firms. The signaling hypothesis shows that asymmetric information between managers and investor, dividend work as signal regarding current performance and future prospect. The study found that high dividend has positive effect on the firm performa nce, in term of providing a positive signal for current performance and as will as future scenario. In addition, dividend payout reduces the free cash flow problem, which may attract the manager to invest in negative NPV project for personal interest. But if the project shows positive NPV so investment opportunities are ready(prenominal) which lead toward the higher dividend in future.Gill, Nahum, and Rajendra (2010) worked on determinants of dividend payout ratio in United States. In this study researcher extend the Amidu and Joshua, and indigotin and Kapoor finding for the American service and manufacturing firms. Researcher took same variables into account much(prenominal) as profitability, tax, market to book value, cash flow, and sale growth. The example size was 266 out of 500 financial reports. According to the researcher dividend payout ratio of manufacturing firms is the function of profit margin, tax, and market to book value ratio. It was also found that result differ when the dividend payout ratio was defined as the ratio between after tax cash flow and cash dividend, not considering after tax earning of the companies.Reddy (2006), examine the dividend behavior of Indian companies, movement, and determinants and struggled to decide the behavior of the companies listed at Bombay Stock Exchange with theassist of trade by theory and signaling theory hypothesis. According to researcher analysis of dividend trend represent that transmit traded on peeled York Stock Exchange and Bombay Stock Exchange indicated that percentage of companies paying dividend has declined from 60.5% in 1990 to 32.1% in 2001 and there is only few companies paying dividend constantly. Beside that firms paying dividend are more profitable, large in size, and having enough growth. Indian context did not represent corporate tax and ax preference theory. last the dividend change indicated signal to current and lagged earning performance rather than future earning perform ance.Baker, Farrelly and Edelman (1986) studied New York Stock Exchange 318 firms. According to the researchers main determinants of dividend payments were expected future earning and express of past dividend. Gitman and Pruitt (1991) asked snow0 largest US firms financial managers and concluded present and reason year earning were significant determinants effect dividend payment. According to Baker and Powell (2000) survey companies listed on New York Stock Exchange were industry explicit and predicted level of future income was the main factor of dividend payoutAnil and Kapoor (2008) studies Indian information technology firmament for determinants of dividend payout ratio. The phase for study 2000-2006 encompass both recessionary and booming phase of Indian information technology sector. Researcher concluded that beta and liquidity was discover a noteworthy determinant of dividend payout ratio. In addition, authors concluded that due to recession from 2003 onwards IT sector o bserved exponential growth, and it was anticipated linear growth in IT sector after 2006.Recently in Pakistani perspective, Ahmed and Attiya (2009) investigated sample of 320 non-financial firms listed on Karachi Stock Exchange from 2001 to2006.Researchers concluded Pakistani companies dependent more on current earning than past dividend. In addition, authors highlighted few predictors that may affect payout policies. Firstly, the finding demonstrated companies containing high profit with consistent earning can manage larger amount of free cash flow as a result to payout larger dividend. The firms having larger investment expectation can easily affect and have a significant role in determinants of dividend payout policy in Pakistan. The companies paid more dividends to shareholders where inside ownership exist. Ownership structure has considered major factor in determining dividend policy in Pakistan. Beside that dividend payout was not touched pay growth of the firms and market l iquidity has a significant impact on dividend payout. Furthermore, size was significant determinants for dividend payout that promoter companies invest in assets relatively paying dividends to its stockholders.2.1 Dividend irrelevance theoryMiller and Modigliani (1961) proposed that dividend policy is irrelevant to the shareholder and stockholder wealth was constant in the world of perfect market condition and any growth in the current payout is financed by literally damaged stock sales. The basic assumption was that management paid 100 percent payout in each period. Other assumptions were as follow.First, market is perfect capital market that authority there were no taxes on transaction cost, single buyer and seller not influenced price and everyone have free access to information.Second, investors are rational and value of securities was based on the discounted future cash flow to investor.Third, manager act as a agent of shareholders, and there was no uncertainty about the in vestment policy of the firm.2.2 Bird-in-hand theoryAl-Malkawi (2007) emphasized that dividend valued differently from retained earnings (capital gains) in world of ambiguity and irregularity information. A bird in hand (dividend) is valued more than two in the bush (capital gain)?. Investors always like dividends to retained earnings due to uncertainty of future cash flow. Although, this controversy has been extensively condemned and has not get strong empirical base, but, it was supported by Gordon and Shapiro (1956), Lintner (1962), and Walter (1963). The basic assumptions were as followedFirstly, investors have inadequate information regarding the profitability of a firm.Secondly, cash dividend was taxed at a higher rate when capital gain was realized on the sale of share.Thirdly, dividend serves as a signal of expected cash flow.2.3 Agency cost and free cash flow theoryRoss (2008) define agency cost is the cost of the conflict of interest that exists among shareholders and mana gement. It was happened when management act for own interest rather than shareholders interest who own the firm. This could be direct and indirect. It was in contrast to assumption of Millar and Modigliani (1961) that mangers act as an agent of shareholders. This is somewhat dubious, as the owners of the firm are different from the management. Managers are bound to carry out some activities, which could be costly to shareholders, such(prenominal)(prenominal) as undertaking unprofitable investments that would yield excessive returns to them, and unnecessarily high management compensation (Al-Malkawi, 2007). These costs are borne by shareholders therefore, shareholders of firms with excess free cash flow would require high dividend payments instead. Agency cost may also arise between shareholders and bondholders while shareholders require more dividends, bondholders require fewer dividends than shareholders by putting in place a debt covenant to ensure availability of cash for their debt repayment. Easterbrook (1984) also identified two agency costs the cost of monitor managers and the cost of risk reluctance on the part of managers. Jensens free cash flow/overinvestment hypothesis (1988) provides a surrogate description for the positive association between the direction of the dividend change and the stock price reaction. Jensen argues that managers tend to hold cash to invest in negative NPV projects for their own utility maximization. The agency costs that result from this overinvestment decrease the value of the firm. Like the signaling hypothesis, the FCF argument suggests there should be a positive relationship is the direction of the dividend policy change and the stock price reaction. However, the FCF argument differentiates itself with respect to the level of growth opportunities faced by the firm. If a firm initiated a cash dividend, FCF arguments postulate there are fewer funds available for costly overinvestment. Likewise, if federation didnt pay d ividend, the strongest form of a decrease would reduce the value of the firm because there are more funds available to invest in less present value projects. The FCF hypothesis assumes larger stock price unpredictability for the firms who have few growth opportunities as compared to the firms with many growth opportunities.There is disagreement between different researchers on dividend policy. Allen and Rachim (1996) in Australia found no significant association between stock price volatility and divided policy. According to Gordon (1963) the stock price volatility is influenced by dividend payout. The firms who pay large dividend have minimum risks in terms of stock price value. around of hypothetical mechanism also suggests the universal relationship of dividend yield and dividend payout ratio with stock price volatility.Jensens and Meckling (1976) developed Agency cost argument which proposed that dividend payout lower the cost of funds and increase the cash flows for the compa ny. The company after paying cash dividends to stock holders would have less cash in hands of the managers to invest at below the cost of capital.According to Asquith and Mullin (1983), Born, Moser, and Officer (1984) and Miller and Rock (1985) dividend announcement provide information to the share holders to forecast the financial position of the company and the present firms earnings. This also depends on the source of information that either it is doubtful or not to respond on announcement of dividend. Hence, there remains disagreement till yet, the relation of dividend yield and stock price volatility and it is still undetermined and is considered as debatable in corporateCHAPTER 3RESEARCH METHODS3.1 Method of entropy CollectionRequired data was collected from Karachi Stock Exchange as given by State Bank of Pakistan in publication of Balance winding-sheet Analysis of Joint Stock Companies Listed on the KSE (2005-2009). The period of study covered five years, 2005-09. The sa mple size of 100 non-financial firms was taken from all non financial firm listed at KSE. The required sample was chosen on the basis of cash dividend paid by firms at- least(prenominal) for two years. The sample represents major industry.3.2 try out SizeSample of 100 non-financial firms was collected from KSE. Sample consisted of firms which paid cash dividend for at least two years. Firms that was selected for study represented all major industries functioning in Pakistan and listed at KSE from 2005-2009. The impact of the cash flow and profitability on dividend payout was examined on selected sample of 100 non-financial firms.3.3 Research Model DevelopedThere were various financial factors of the non-financial firms which affected the Dividend payout of the firms. This research study investigated the impact of free cash flow and profitability on the dividend payout.3.3.1 Dividend payoutDividend payout and dividend amount are taken as the dependent variables. Since dividend payou t is the generally used alternative for dividend policy, almost every financial researcher has used payout as a proxy for corporate dividend policy (See for example Gugler, 2003 Reddy and Rath, 2005 Papadopoulos, 2007 Al-Malkawi, 2007 Ahmed Attiya, 2009). In order to solve dividend payout was calculated as cash dividend per share divided by earning per share.3.3.2 Earning per shareAccording to Hafeez and Attiya (2009) high profitability with constant earnings can manage to pay for larger free cash flows as a result to pay out larger dividends. The earnings per share after tax were used as independent variable. Earning per share after tax was used because dividend has been paid after interest, taxes and after depreciation and calculated as net earnings divided by number of shares.H1 There is significant impact of earning per share on dividend payout3.3.3 repay on EquityThis variable is used in different previous studies such as Abor (2005), Miller (2007), Al-Ajmi et al. (2009), an d Ebaid (2009) etc. Some authors heedful profitability or performance by three measurements such Gross profit margin (GPM), damages on Equity (ROE), and go by on Assets (ROA) and same predictors Ebaid (2009). Likely results with this variable are same as revealed by Abor (2005) and Ebaid (2009) such as Significance and positive relationship with dividend payout. Return on Equity is considered best measure of firm profitability. Return on Equity (ROE) is one measure of how efficiently a company uses its assets to produce earnings. ROE was calculated by dividing Net Income minus preferable dividend by Share holder equityH2 There is significant impact of Return on Equity on dividend payout.3.3.4 sluttish Cash flowAccording to Jensens (1986) free cash flow hypothesis, companies choose to use their cash resources to invest in profitable projects first dividend is paid out of residual. From a companys point of view, cash generated from operations plays an important role in deciding t he level of payout, among all three sources of cash flows i.e. operating investing and financing, cash generated from operations is considered as most desirable source of funds for the company for distribution of dividends. Anil and Sujjata (2008) also found cash flow from operations as the most significant determinant of dividend policy in Indian IT industry. Ameasure of financial performance calculated as Net income minus depreciation minus change in working capital minus change in capital expenditure. Free cash flow (FCF) represents the cash that a company is able to generate afterplacing out the money required to maintain or expand its asset base.Freecash flow is important because itallows a company topursue opportunities that put forward shareholder value.H3 There is a significant impact of free cash flow on dividend payout.The model developed was a linear model and its specifications are provided belowDiv payout = a0 a1EPS + a2ROE + a3FCF + Dividend payout = Dividend per sha re divided by earning per shareEPS = Net income divided by number of share outstandingROE =Net income minus preferred dividend divided by common shareholder equityFCF =Net income minus derogation minus change in working capital minus change in Capital expenditure = error term3.4 Statistical Technique manifold Linear Regression Analysis (MLR) technique was used for this research study to examine the impact of the distinctive financial characteristics of the non-financial firms on their dividend payout of the selected firms Statistical Package for the complaisant Sciences (SPSS) was used for the examination of the secondary data.CHAPTER 4RESULTThe sample of 100 non-financial firms from Karachi Stock Exchange was taken into consideration. This research study used multiple statistical throwback analysis (MLR). Researcher examined the behavior of non-financial firms of KSE about dividend payout. The selected technique was used to study the impact of cash flow and profitability on div idend payout.4.1 Finding and Interpretation of the resultsIn the beginning, the regression technique was applied on collected data by using SPSS, and there was no single variable was significant. It was clear from the result that there was the high co-linearity among the independent variables of the dividend payout and this means there was strong interrelationship present among the predictors. Return on assets and net profit margin was omitted from the data, thus, the issue of co-linearity was resolved.Now, proceeding with the analysis of the results because issue of co-linearity was addressed. The interpretation and analysis is presented in the next sections of this research study. panel 4.1 Model SummaryModRR Sq.Adj. R Sq.1.289.084.078Tables 4.1 interpret the summary about the regression model. The R square of 8.4% showed that all the predictors of dividend payout unneurotic explained 8.4% variation in the dependent variable and the remaining variation was unexplained or hidden predictor were not included in the model.TABLE 4.2analysis of varianceModelSum of SquaresdfMean SquareFSig.1Regression31503.936310501.31215.236.000aResidual345316.428501689.254Total376820.364504The table 4.2 checked the significance of the linear regression model in such a way that the reliability of the data archive regarding the applicability of the regression technique can be understood from the supra table however, ANOVA table was reliable test of checking the linear regression models ability to explain any variation in the dependent variable of liquidity. This was short obvious from the sig value of .000 that meant that the linear regression model was highly significant for the data collected for the research study conducted. In addition, ANOVA explained that all means are not equal.In table4.3 the final model of regression included only three independent variable that were free cash flow, earning per share, and return on equity These variables were included in the model due to highly significantly describing the relation with dependent variable dividend payout. Returns on equity and free cash flow have positive impact on dividend, while earning per share has negative impact on dividend payout.4.2 Hypothesis Assessment SummaryThe hypothesis of research was preposterous financial factors had significant impact on the non-financial firms dividend payout decision. These financial characteristics were cash flow taken as free cash flow of firms and profitability taken as earning per share and return on Equity of firms. This research tasted individual financial characteristics and concluded the result as follow.TABLE 4.4 Hypothesis Assessment SummaryS.No.HypothesisSIG.RESULTH1There is significant impact of free cash flow on dividend payout..001.005 currentH2There is significant impact of Return on equity on dividend payout..216000AcceptedH3There is significant impact of Earning per Share on dividend payout.-.123.016AcceptedH4There is significant impact of Re turn on Assets on dividend payout..340.170 jiltedH5There is significant impact of Net profit margin on dividend payout.-.034.530 spurnedCHAPTER 5DISCUSSIONS, IMLICATION, FUTURERESEARCH AND CONCLUSION5.1ConclusionIt was concluded with support of results of this research study return on equity, earning per share, and free cash flow were significant independent variables in Pakistani market. These result were matching with the study under taken by Hafeez and Attiya (2009) in Pakistani context, Researchers concluded firms with high profitability and with stable earning can afford larger free cash flow therefore pay out larger dividends to its shareholder. In addition, Talat and Hammad (2010) examined the ownership structure and cash flow as determinants of dividend policy. Researchers concluded that companies in which high proportion of share were occupied by managers and individual were more reluctant of pay high dividends. In contrast, companies in which managerial and individual owne rship is low paid less dividends. It was also concluded that companies having high operating cash flow increase companies potential to pay high dividend and it was considered cash flow sensitivity reduce the companies payout but still it was not determined as potential determinants of corporate payout in Pakistan.5.2 DiscussionsProfitability and free cash flow could lay significant impact on dividend payout in Pakistani context. Hafeez and Attiya(2009) was also considered profitability as significant determinant of dividend payout, But study conducted by Talat and Hammad (2010) concluded operating cash flow cannot consider significant determinant of dividend payout in Pakistani market.This research considered that free cash flow and profitability measured through earning per share and returns on equity have significant impact on dividend payout of the companies.5.3 Implication and RecommendationsThis research was encompasses non-financial companies listed on Karachi Stock Exchange P akistan. The required data collected from 100 non-financial firms listed at KES for the period of 2005 t0 2009. Only firms were included in samples which were paid cash dividend for atleast two years. It is recommended that such type of study should be carried out in other countries of Asia. Further, it also recommended that other determinants except one analyze in this study should be researched in more extensive manner so the dividend payout policy and its dynamics became clearer.5.4 Future ResearchThis research addressed the problems of investor, management and other researcher conductor in examining and observing the behavior of firm regarding their payout decisions. Research students who want to work further on dividend payout could be benefited by this study. In addition, all non financial firms will get benefit from this study because this research study taken all major sectors into the consideration and study clarified the impact of free cash flow and profitability on divide nd payout.Cash Flow and Profitability of Dividend PayoutCash Flow and Profitability of Dividend PayoutCHAPTER 1INTRODUCTIONOverviewThe issue of dividend has been studied comprehensively in last few decades. Still it remained as one of the most debatable issue in the field of Finance. The contradictory nature and massive importance 0f dividend in finance had made it one of the most discussable topics for researchers. Researchers in the past enclosed many aspects of dividend few among them are views about dividend, dividend payment effects on firm value, dynamics and determinants of dividend policy, and dividend movement of different markets.Lintner (1956) study the allocation of income of corporations among dividends, retained earnings and taxes by taking data from the years 1918 to 1941 as a training period and data from the years 1942 to 1951 as the testing period. Researchconcluded that the basic origin of dividend changes werenet earning and preceding year dividends. In addition, firms attempt to continue a constant stream of dividend and influence to make a regularly partial adjustment to a target payout ratio relatively hysterically changing their payout when a change in income occurs. In the short run, dividends are consistent to avoid frequent changes. This dispute is rooted back to the significant effort of Miller and Modigliani (1961), in which it was challenged in a perfect market condition dividend policy did not affect the value of firm. In contrast, Lintner (1962) and Gordon (1963) based Bird-in-hand? theory and argued that in the world of ambiguity and imperfect information, high dividend payment is linked with high firm value. In addition, Black (1976) called dividend as great puzzle which need extensive researched. Furthermore, the Brealey and Myers (2005) listed dividend as one of the top ten significantvague topic in advance corporate finance. According to Anil and Sujjata(2008) emerging consensus was that no individual factor alone can descr ibe dividend behavior.The existing corporate theories supported that cash flow and profitability have significant impact on dividend. The aim of this study was to know the impact of cash flow and profitability on dividend payout of non financial firms in Pakistan market. This study considered free cash flow and profitability was most important for non financial firm in Pakistan market. Talat and Mirza(2010) conducted research related to ownership structure and cash flow as predictor of dividend payout policy. According to that personal ownership, cash flow delicacy, size, and leverage were negatively associated with dividend payout policy. In contrast, profitability and operating cash flow was found as determinants of cash dividend. In addition, Researcher concluded that executive ownership, personal ownership, operating cash flow, and size were important determinants of dividend while, leverage and cash flow delicacy did not contribute considerably in determining the level of corpo rate dividend payment. DeAngelo and DeAngelo (1990) found significant relation between cash flow and dividend changes.Problem StatementIn the field of corporate finance, the dividend was considered as one of the most noteworthy issues. The main purpose to study the impact of cash flow and profitability on dividend payout of non financial firm in Pakistani market was to analyze the cash dividend behavior of developing countries firm. In addition, study was conducted to find out how strongly these two variables free cash flow and profitability have impact on the dividend payout because, profitability was most likely used as determinants of dividend payout in most of the previous researches but free cash flow was not taken too much in previous research. Furthermore, how these two variables serve as an indicator for dividend payout.HypothesisThis research study has tested the following hypothesis to fulfill the objective of the research.H1 There is significant impact of free cash flow o n dividend payout.H2 There is significant impact of return on assets on dividend payout.H3 There is significant impact of return on equity on dividend payout.H4 There is significant impact of earning per share on dividend payout.H5 There is significant impact of net profit margin on dividend payout.Outline of the StudyThe research structured follows. Chapter one was consist on the introduction of the thesis, it is essential to review the views and theoretical background of dividend, the statement o problem, scope and objective, hypothesis. Chapter two consisted of literature review given by various authors, theories on dividend and impact of cash flow and profitability on dividend payout. Chapter three explained methodology, it consisted of explanation of the selection of the variables, the sampling and research design, the data technique and hypothesis. Chapter four represents the analysis of results after processing the data. Chapter five composed of final result, conclusion and r ecommendation. Chapter six consisted of references.CHAPTER 2LITERATURE REVIEWSince 1956, dividend has always considered one of the most interested and investigated topic in world of finance.Lintner (1956) analyzed the allocation of earning of corporation among dividends, retained earnings, and taxes by taken data into consideration for years 1918 to 1941. It was found the basic determinants of dividend change are net earning and preceding year dividends. In addition, firms tried to continue a stable flow of dividend and likely made a regularly limited adjustment to a target payout ratio instead radically changing payout when earning changed.Jensen and Meckling (1976) paid attention toward agency cost hypothesis and described that dividend restricted the funds under management control, as a result putting them under strict capital market examination. Owner responsibility was reduced to deal with the quality of investment and to handle the expenditure on manager prerequisites.Marke, L angrehr, and Hexter(1998) conducted research on dividend policy determinants. Researchers had taken focus of firm, natural log of sales of firm, inside ownership for firm, no of common shareholder for firm, free cash flow for firm, sales growth of firm, and standard deviation of returns o f firm as determinants of dividend policy. Authors concluded that corporate focus has negative impact on dividend payout. While inside ownership had also negative impact, according to researcher the firms have greater inside ownership have small dividend payout. In addition, the firms with higher free cash flow have higher dividend payout and lower payout ratio of firms with higher standard deviation of returns.William and Nanda (1994) conducted research on free cash flow, shareholder value, and the unallocated profits after tax of 1936 and 1937. In this study researcher tried to explore the investor reaction toward the anticipated decrease in free cash flow presented to corporate managers. In addi tion, researchers suggested agency costs as partial determinants of dividend policy. To avoid the agency problem corporate have to pay higher dividend and imposed higher tax on undistributed profit so the problem of agency cost handled efficiently.The study conducted on determinants of dividend payout ratio in GhannabyAmidu and Abor (2006). In this study 20 listed firms of Ghana Stock Exchange were used as a sample which shows 76% of the total listed firm in Ghana Stock Exchange. Researchers have taken the Payout Ratio as controlled variable and explanatory variables includes risk, profitability, cash flow, corporate tax, institutional holding, sales growth, and market to book value. It was foundthat more profitable firms paid more dividends and profitability is positively related to dividend payout. In addition, cash flow and taxes are also positively related to dividend payout. Further, they also concluded there is a positive relationship between increase in liquidity and dividend payout. Results suggested negative relationship of dividend payout with growth, market to book value, risk, and institutional holding. The firms with the earning instability found hard to pay low and no dividends.Al-Malkawi (2007) worked on determinants of corporate dividend payout policy in Jordan. Researcher used a firm level panel data of all publicly traded firms on the Amman Stock Exchange for the year 1989-2000. Researcher used dividend payout as a depended variable and agency cost, Ownership, annual share turnover, market to book ratio, market capitalization of common equity, financial leverage ratio, profitability ratio, and taxes as independent variables. By using Tobit specification researcher concluded that positive relationship between size, age, and profitability with dividend payout and negative relationship between signaling device, ownership, and taxes in Jordan.Fairchild (2010) worked on Dividend policy, signaling and free cash flow an integrated approach. Research er has tried to examine the dividend policy by taking only two hypothesis signaling and free cash flow. In order to understand the composite environment of dividend policy, signaling game is developed in which most of the information possesses by managers than investors about the quality of the firms. The signaling hypothesis shows that asymmetric information between managers and investor, dividend work as signal regarding current performance and future prospect. The study found that high dividend has positive effect on the firm performance, in term of providing a positive signal for current performance and as will as future scenario. In addition, dividend payout reduces the free cash flow problem, which may attract the manager to invest in negative NPV project for personal interest. But if the project shows positive NPV so investment opportunities are available which lead toward the higher dividend in future.Gill, Nahum, and Rajendra (2010) worked on determinants of dividend payout ratio in United States. In this study researcher extend the Amidu and Joshua, and Anil and Kapoor finding for the American service and manufacturing firms. Researcher took same variables into account such as profitability, tax, market to book value, cash flow, and sale growth. The sample size was 266 out of 500 financial reports. According to the researcher dividend payout ratio of manufacturing firms is the function of profit margin, tax, and market to book value ratio. It was also found that result differ when the dividend payout ratio was defined as the ratio between after tax cash flow and cash dividend, not considering after tax earning of the companies.Reddy (2006), studied the dividend behavior of Indian companies, movement, and determinants and struggled to decide the behavior of the companies listed at Bombay Stock Exchange with theassist of trade off theory and signaling theory hypothesis. According to researcher analysis of dividend trend depicted that stock traded on Ne w York Stock Exchange and Bombay Stock Exchange indicated that percentage of companies paying dividend has declined from 60.5% in 1990 to 32.1% in 2001 and there is only few companies paying dividend constantly. Beside that firms paying dividend are more profitable, large in size, and having enough growth. Indian context did not represent corporate tax and ax preference theory. Lastly the dividend change indicated signal to current and lagged earning performance rather than future earning performance.Baker, Farrelly and Edelman (1986) studied New York Stock Exchange 318 firms. According to the researchers main determinants of dividend payments were expected future earning and picture of past dividend. Gitman and Pruitt (1991) asked 1000 largest US firms financial managers and concluded present and precedent year earning were significant determinants effect dividend payment. According to Baker and Powell (2000) survey companies listed on New York Stock Exchange were industry explicit and predicted level of future income was the main factor of dividend payoutAnil and Kapoor (2008) studies Indian information technology sector for determinants of dividend payout ratio. The phase for study 2000-2006 encompass both recessionary and booming phase of Indian information technology sector. Researcher concluded that beta and liquidity was discovered a notable determinant of dividend payout ratio. In addition, authors concluded that due to recession from 2003 onwards IT sector observed exponential growth, and it was anticipated linear growth in IT sector after 2006.Recently in Pakistani perspective, Ahmed and Attiya (2009) investigated sample of 320 non-financial firms listed on Karachi Stock Exchange from 2001 to2006.Researchers concluded Pakistani companies dependent more on current earning than past dividend. In addition, authors highlighted few predictors that may affect payout policies. Firstly, the finding demonstrated companies containing high profit with consisten t earning can manage larger amount of free cash flow as a result to payout larger dividend. The firms having larger investment chance can easily affect and have a significant role in determinants of dividend payout policy in Pakistan. The companies paid more dividends to shareholders where inside ownership exist. Ownership structure has considered major factor in determining dividend policy in Pakistan. Beside that dividend payout was not affected pay growth of the firms and market liquidity has a significant impact on dividend payout. Furthermore, size was significant determinants for dividend payout that means companies invest in assets relatively paying dividends to its stockholders.2.1 Dividend irrelevance theoryMiller and Modigliani (1961) proposed that dividend policy is irrelevant to the shareholder and stockholder wealth was constant in the world of perfect market condition and any growth in the current payout is financed by literally priced stock sales. The basic assumption was that management paid 100 percent payout in every period. Other assumptions were as follow.First, market is perfect capital market that means there were no taxes on transaction cost, single buyer and seller not influenced price and everyone have free access to information.Second, investors are rational and value of securities was based on the discounted future cash flow to investor.Third, manager act as a agent of shareholders, and there was no uncertainty about the investment policy of the firm.2.2 Bird-in-hand theoryAl-Malkawi (2007) emphasized that dividend valued differently from retained earnings (capital gains) in world of ambiguity and irregularity information. A bird in hand (dividend) is valued more than two in the bush (capital gain)?. Investors always preferred dividends to retained earnings due to uncertainty of future cash flow. Although, this controversy has been extensively condemned and has not get strong empirical base, but, it was supported by Gordon and Shapir o (1956), Lintner (1962), and Walter (1963). The basic assumptions were as followedFirstly, investors have inadequate information regarding the profitability of a firm.Secondly, cash dividend was taxed at a higher rate when capital gain was realized on the sale of share.Thirdly, dividend serves as a signal of expected cash flow.2.3 Agency cost and free cash flow theoryRoss (2008) define agency cost is the cost of the conflict of interest that exists among shareholders and management. It was happened when management act for own interest rather than shareholders interest who own the firm. This could be direct and indirect. It was in contrast to assumption of Millar and Modigliani (1961) that mangers act as an agent of shareholders. This is somewhat dubious, as the owners of the firm are different from the management. Managers are bound to carry out some activities, which could be costly to shareholders, such as undertaking unprofitable investments that would yield excessive returns to them, and unnecessarily high management compensation (Al-Malkawi, 2007). These costs are borne by shareholders therefore, shareholders of firms with excess free cash flow would require high dividend payments instead. Agency cost may also arise between shareholders and bondholders while shareholders require more dividends, bondholders require fewer dividends than shareholders by putting in place a debt covenant to ensure availability of cash for their debt repayment. Easterbrook (1984) also identified two agency costs the cost of monitoring managers and the cost of risk reluctance on the part of managers. Jensens free cash flow/overinvestment hypothesis (1988) provides a surrogate description for the positive association between the direction of the dividend change and the stock price reaction. Jensen argues that managers tend to hold cash to invest in negative NPV projects for their own utility maximization. The agency costs that result from this overinvestment decrease the value o f the firm. Like the signaling hypothesis, the FCF argument suggests there should be a positive relationship is the direction of the dividend policy change and the stock price reaction. However, the FCF argument differentiates itself with respect to the level of growth opportunities faced by the firm. If a firm initiated a cash dividend, FCF arguments postulate there are fewer funds available for costly overinvestment. Likewise, if company didnt pay dividend, the strongest form of a decrease would reduce the value of the firm because there are more funds available to invest in less present value projects. The FCF hypothesis assumes larger stock price volatility for the firms who have few growth opportunities as compared to the firms with many growth opportunities.There is disagreement between different researchers on dividend policy. Allen and Rachim (1996) in Australia found no significant association between stock price volatility and divided policy. According to Gordon (1963) the stock price volatility is influenced by dividend payout. The firms who pay large dividend have minimum risks in terms of stock price value. Some of hypothetical mechanism also suggests the universal relationship of dividend yield and dividend payout ratio with stock price volatility.Jensens and Meckling (1976) developed Agency cost argument which proposed that dividend payout lower the cost of funds and increase the cash flows for the company. The company after paying cash dividends to stock holders would have less cash in hands of the managers to invest at below the cost of capital.According to Asquith and Mullin (1983), Born, Moser, and Officer (1984) and Miller and Rock (1985) dividend declaration provide information to the share holders to forecast the financial position of the company and the present firms earnings. This also depends on the source of information that either it is doubtful or not to respond on announcement of dividend. Hence, there remains disagreement till yet , the relation of dividend yield and stock price volatility and it is still unexplained and is considered as debatable in corporateCHAPTER 3RESEARCH METHODS3.1 Method of Data CollectionRequired data was collected from Karachi Stock Exchange as given by State Bank of Pakistan in publication of Balance Sheet Analysis of Joint Stock Companies Listed on the KSE (2005-2009). The period of study covered five years, 2005-09. The sample size of 100 non-financial firms was taken from all non financial firm listed at KSE. The required sample was chosen on the basis of cash dividend paid by firms at-least for two years. The sample represents major industry.3.2 Sample SizeSample of 100 non-financial firms was collected from KSE. Sample consisted of firms which paid cash dividend for at least two years. Firms that was selected for study represented all major industries functioning in Pakistan and listed at KSE from 2005-2009. The impact of the cash flow and profitability on dividend payout was e xamined on selected sample of 100 non-financial firms.3.3 Research Model DevelopedThere were various financial factors of the non-financial firms which affected the Dividend payout of the firms. This research study investigated the impact of free cash flow and profitability on the dividend payout.3.3.1 Dividend payoutDividend payout and dividend amount are taken as the dependent variables. Since dividend payout is the generally used alternative for dividend policy, almost every financial researcher has used payout as a proxy for corporate dividend policy (See for example Gugler, 2003 Reddy and Rath, 2005 Papadopoulos, 2007 Al-Malkawi, 2007 Ahmed Attiya, 2009). In order to calculate dividend payout was calculated as cash dividend per share divided by earning per share.3.3.2 Earning per shareAccording to Hafeez and Attiya (2009) high profitability with constant earnings can manage to pay for larger free cash flows as a result to pay out larger dividends. The earnings per share after t ax were used as independent variable. Earning per share after tax was used because dividend has been paid after interest, taxes and after depreciation and calculated as net earnings divided by number of shares.H1 There is significant impact of earning per share on dividend payout3.3.3 Return on EquityThis variable is used in different previous studies such as Abor (2005), Miller (2007), Al-Ajmi et al. (2009), and Ebaid (2009) etc. Some authors measured profitability or performance by three measurements such Gross profit margin (GPM), Return on Equity (ROE), and Return on Assets (ROA) and same predictors Ebaid (2009). Likely results with this variable are same as revealed by Abor (2005) and Ebaid (2009) such as Significance and positive relationship with dividend payout. Return on Equity is considered best measure of firm profitability. Return on Equity (ROE) is one measure of how efficiently a company uses its assets to produce earnings. ROE was calculated by dividing Net Income min us preferred dividend by Share holder equityH2 There is significant impact of Return on Equity on dividend payout.3.3.4 Free Cash flowAccording to Jensens (1986) free cash flow hypothesis, companies choose to use their cash resources to invest in profitable projects first dividend is paid out of residual. From a companys point of view, cash generated from operations plays an important role in deciding the level of payout, among all three sources of cash flows i.e. operating investing and financing, cash generated from operations is considered as most desirable source of funds for the company for distribution of dividends. Anil and Sujjata (2008) also found cash flow from operations as the most significant determinant of dividend policy in Indian IT industry. Ameasure of financial performance calculated as Net income minus depreciation minus change in working capital minus change in capital expenditure. Free cash flow (FCF) represents the cash that a company is able to generate after placing out the money required to maintain or expand its asset base.Freecash flow is important because itallows a company topursue opportunities that enhance shareholder value.H3 There is a significant impact of free cash flow on dividend payout.The model developed was a linear model and its specifications are provided belowDiv payout = a0 a1EPS + a2ROE + a3FCF + Dividend payout = Dividend per share divided by earning per shareEPS = Net income divided by number of share outstandingROE =Net income minus preferred dividend divided by common shareholder equityFCF =Net income minus Depreciation minus change in working capital minus change in Capital expenditure = error term3.4 Statistical TechniqueMultiple Linear Regression Analysis (MLR) technique was used for this research study to examine the impact of the distinctive financial characteristics of the non-financial firms on their dividend payout of the selected firms Statistical Package for the Social Sciences (SPSS) was used for the examination of the secondary data.CHAPTER 4RESULTThe sample of 100 non-financial firms from Karachi Stock Exchange was taken into consideration. This research study used multiple regression analysis (MLR). Researcher examined the behavior of non-financial firms of KSE about dividend payout. The selected technique was used to study the impact of cash flow and profitability on dividend payout.4.1 Finding and Interpretation of the resultsIn the beginning, the regression technique was applied on collected data by using SPSS, and there was no single variable was significant. It was clear from the result that there was the high co-linearity among the independent variables of the dividend payout and this means there was strong interrelationship present among the predictors. Return on assets and net profit margin was omitted from the data, thus, the issue of co-linearity was resolved.Now, proceeding with the analysis of the results because issue of co-linearity was addressed. The interpret ation and analysis is presented in the next sections of this research study.Table 4.1 Model SummaryModRR Sq.Adj. R Sq.1.289.084.078Tables 4.1 depict the summary about the regression model. The R square of 8.4% showed that all the predictors of dividend payout together explained 8.4% variation in the dependent variable and the remaining variation was unexplained or hidden predictor were not included in the model.TABLE 4.2ANOVAModelSum of SquaresdfMean SquareFSig.1Regression31503.936310501.31215.236.000aResidual345316.428501689.254Total376820.364504The table 4.2 checked the significance of the linear regression model in such a way that the reliability of the data file regarding the applicability of the regression technique can be understood from the above table however, ANOVA table was reliable test of checking the linear regression models ability to explain any variation in the dependent variable of liquidity. This was perfectly obvious from the sig value of .000 that meant that the linear regression model was highly significant for the data collected for the research study conducted. In addition, ANOVA explained that all means are not equal.In table4.3 the final model of regression included only three independent variable that were free cash flow, earning per share, and return on equity These variables were included in the model due to highly significantly describing the relation with dependent variable dividend payout. Returns on equity and free cash flow have positive impact on dividend, while earning per share has negative impact on dividend payout.4.2 Hypothesis Assessment SummaryThe hypothesis of research was unique financial factors had significant impact on the non-financial firms dividend payout decision. These financial characteristics were cash flow taken as free cash flow of firms and profitability taken as earning per share and return on Equity of firms. This research tasted individual financial characteristics and concluded the result as follow.TA BLE 4.4 Hypothesis Assessment SummaryS.No.HypothesisSIG.RESULTH1There is significant impact of free cash flow on dividend payout..001.005AcceptedH2There is significant impact of Return on equity on dividend payout..216000AcceptedH3There is significant impact of Earning per Share on dividend payout.-.123.016AcceptedH4There is significant impact of Return on Assets on dividend payout..340.170RejectedH5There is significant impact of Net profit margin on dividend payout.-.034.530RejectedCHAPTER 5DISCUSSIONS, IMLICATION, FUTURERESEARCH AND CONCLUSION5.1ConclusionIt was concluded with support of results of this research study return on equity, earning per share, and free cash flow were significant independent variables in Pakistani market. These result were matching with the study under taken by Hafeez and Attiya (2009) in Pakistani context, Researchers concluded firms with high profitability and with stable earning can afford larger free cash flow therefore pay out larger dividends to it s shareholder. In addition, Talat and Hammad (2010) examined the ownership structure and cash flow as determinants of dividend policy. Researchers concluded that companies in which high proportion of share were occupied by managers and individual were more reluctant of pay high dividends. In contrast, companies in which managerial and individual ownership is low paid less dividends. It was also concluded that companies having high operating cash flow increase companies potential to pay high dividend and it was considered cash flow sensitivity reduce the companies payout but still it was not determined as potential determinants of corporate payout in Pakistan.5.2 DiscussionsProfitability and free cash flow could lay significant impact on dividend payout in Pakistani context. Hafeez and Attiya(2009) was also considered profitability as significant determinant of dividend payout, But study conducted by Talat and Hammad (2010) concluded operating cash flow cannot consider significant de terminant of dividend payout in Pakistani market.This research considered that free cash flow and profitability measured through earning per share and returns on equity have significant impact on dividend payout of the companies.5.3 Implication and RecommendationsThis research was encompasses non-financial companies listed on Karachi Stock Exchange Pakistan. The required data collected from 100 non-financial firms listed at KES for the period of 2005 t0 2009. Only firms were included in samples which were paid cash dividend for atleast two years. It is recommended that such type of study should be carried out in other countries of Asia. Further, it also recommended that other determinants except one analyzed in this study should be researched in more extensive manner so the dividend payout policy and its dynamics became clearer.5.4 Future ResearchThis research addressed the problems of investor, management and other researcher conductor in examining and observing the behavior of fir m regarding their payout decisions. Research students who want to work further on dividend payout could be benefited by this study. In addition, all non financial firms will get benefit from this study because this research study taken all major sectors into the consideration and study clarified the impact of free cash flow and profitability on dividend payout.