University of KwaZulu-Natal
College of Law and Management Studies
School of Accounting, Economics & Finance
Does Simultaneity between Cash Holding and Dividend Policies hold in Zimbabwe’s Multiple Currency System?
Shepard Munyari
and
Farai Kwenda
SAEF Working Paper No. 2016/01/02
May 2016
Does simultaneity between cash holding and dividend policies hold in Zimbabwe’s multiple currency system?
Shepard Munyari[*]
Farai Kwenda (PhD)**
Abstract
Thispaper examined cash holding and dividend policies employed by listed companies operating in Zimbabwe’s multiple currency system. Determinants of corporate dividend and cash holdings determinants were investigated.Using panel data regression methods on the panel data obtained from financial statements of58 non-financial firms registered at the Zimbabwe Stock Exchange (ZSE) from 2009 to 2014 to determine if simultaneity exists between dividend policy and corporate cash holdings policy. The study found thatdividend payment policy and cash holdings policy influence each other. In addition,dividend and cash holdings are both influenced by common variables namely leverage, working capital ratio and business risk which confirmsthe existence of simultaneous relationship between dividend and corporate cash holdings policies. In line with these findings, the study concluded that it is of paramount importance for financial managers formulate corporate dividend policy and corporate cash holdings simultaneously while at the same time paying special attention to the debt ratio, working capital resources and prevailing business risk.
Key Words:dividend policy, cash holding policy, transitional economy
1Introduction
Financial management is regarded as an important category of business management. The key financial management decisions are; capital budgeting, capital structure, working capital management and the distribution decision. The distribution decision involves decisions about paying out earnings as a dividends versus retaining them in the business to support future growth. Companies should devise strategies and policies of rewarding its equity investors in monetary terms or otherwise to meet their return on investment expectations(Uwuigbe, Jafaru, & Ajayi, 2012). Inselbag (2007) explained that dividend payment by companies is necessary to increase the company share price and therefore, the company value. Cash holding is part of the working capital management decisions that managers make in order to make sure that the company has enough resources to keep its operations running without costly disruptions. It is about making sure that the company the right amount of cash at all times. Holding excessive cash levels causes the firms to get loss because of low returns on cash and marketable securities. Low levels of cash may cause difficulties in meeting obligations as and when they fall due.
Despite the compelling reasons to pay dividends companies often find it difficult to declare and pay dividends to its shareholders. Dividend payments are normally difficult for companies operating in a challenging economic environment like Zimbabwe. From 1999 to 2008 Zimbabwe experienced severe socio-economic and political criseswhich almost brought the whole country to its knees. The inflation rate rose from 15.8 percent in January 1997 (Ministry of Finance, 2006) to 231 150 888.87 percent in July 2008 (Central Statistical Office, 2008). The unemployment rate was above 80 percent and industry utilization rates of below 10 percent (Zinyama & Takavarasha, 2014). Zimbabwe reported a whopping 47.26 percent cumulative decline between 1999 and 2007 (International Monetary Fund, 2008) in its Real Gross Domestic Product (RGDP). In February 2009, Zimbabwe ditched its worthless Zimbabwean dollar (ZWD) and adopted the multiple-currency system. Change in national economic policies and formation of a government of national unity in 2009 changed the economic fortunes of the country. Thus, the country has been in an economic transitional period since 2009.
Table 1 shows that the country managed to tame the inflation dragon[†] and register positive economic growth. Capacity utilization in the manufacturing sector increased in the first three years of the multi-currency regime. From 2012 to 2014 the economy stagnated though inflation has remained under control. Capacity utilisation has declined from 57% in 2011 to 36% in 2014. The slowdown of the economy has been attributed to several structural challenges prevalent in the economy.
Table 1:Real GDP growth and Capacity Utilisation of Zimbabwe’s Manufacturing Firms
Year / 2008 / 2009 / 2010 / 2011 / 2012 / 2013 / 2014RGDP growth rate / 5.4% / 9.6% / 10% / 4.4% / 4.5% / 3.1%
Capacity Utilisation / 10% / 32.3% / 43.7% / 57.2% / 44.9% / 39.6% / 36.3%
Annual inflation rate / - / 3.1% / 3.5% / 3.7% / 1.6% / -0.2%
Source: Ministry of Finance (2010); (Ministry of Finance, 2011, 2012, 2013, 2014, 2015)and Confederation of Zimbabwe Industries (2010); (Confederation of Zimbabwe Industries, 2011, 2012, 2013, 2014)
Despite some economic positives since the adoption of the multiple currency system in 2009, the economic environment is still challenging for businesses. The challenges in the operating environment include liquidity challenges, raw materials shortage, high costs of doing business, power and water shortages, competition from imports, aging machinery, low demand of produced products on the local market and funding constraints ((Mahembe & Odhiambo, 2014).Given these challenges it is important to study the dividend and cash holding policies being employed by Zimbabwean companies, the determinants of such dividend and cash holding policies and if simultaneity between dividend and cash holdings policies. The rest of the paper is organized as follows: Section 2 briefly reviews the literature on dividend and cash holdings policies and the development of hypothesis. Data sources and the sample are described in Section 3. Section 4 presents and analyses the principal findings of the study. The conclusion of the study is presented Section 5.
2Literature Review
This section reviews existing literature on corporate dividend and cash holdings policies, in order to a lay a foundation for suitable dividend policies for companies operating in Zimbabwe’s multiple currency economy. The determinants of corporate dividend and cash holdings policies for Zimbabwe’s multiple currency economy were considered in the context of the simultaneity that exists between corporate dividend policy and corporate cash holdings policy, existing literature on cash holdings policy and the simultaneous relationship between corporate dividend policy and corporate cash holdings policywere considered in this section.
Dividend payment is a distribution or appropriation of profit to shareholders (Badu, 2013). On the other hand, dividend policy refers to “the practice that management follows in making dividend payout decisions or, in other words, the size and pattern of cash distributions over time to shareholders” (Lease, John, Kalay, Loewenstein, & Sarig, 1999). There are two broad types of dividend policies, namely cash dividend policies and non-cash dividend policies (Firer, Ross, Westerfield, & Jordan, 2012). The cash dividend policies include the residual dividend approach, stable dividend approach and compromise dividend approach while non cash dividend policies comprise of share repurchase, script issue and share split(Firer et al., 2012).
Cash holdings refer to the cash on hand or cash available for investment in physical assets and to distribute to investors (Gill & Shah, 2012). According to Damodaran (2005), firms have to decide on how much cash they should hold because cash holdings are important to firms. Firms hold cash in order to reduce transaction costs associated with selling securities to raise cash, to sustain profitable investments, to venture into new opportunities, to replenish depleted stock, for survival during crisis period and also for precautionary reasons(Al-Amri, Al-Busaidi, & Akguc, 2015; Baskin, 1987; Damodaran, 2005; Opler, Pinkowitz, Stulz, & Williamson, 2001; Sánchez & Yurdagul, 2013). Firms should therefore maintain adequate cash holdings to meet the above. According to Damodaran (2005) the adequacy of cash holdings is determined in terms of three measurements, which are cash as a percentage of market value of firm, cash as a percentage of book value of all assets andcash as a percentage of firm’s revenues. Thus, cash holdings policy relates to the cash target ratio given by any of the three measurements.
The choices of corporate dividend policy and corporate cash holdings policy are determined by various factors. Existing literature points to the fact that the two corporate policies are influenced by common factors that are explained below.
Determinants of cash holdings and dividend policies: hypotheses development
Firm Size:Firm size is defined as the natural logarithm of sales or assets (Kowalewski, Stetsyuk, & Talavera, 2007; Ullah, Fida, & Khan, 2012).A positive relationship exists between dividend policy and firm size (Mehta, 2012; Uwuigbe et al., 2012).Small firms are likely to have lower dividend payout ratios than large firms. Firm size has a positive relationship with cash holdings policy(Islam, 2012; Kariuki, Namusonge, & Orwa, 2015; Koshio, 2005). Larger firms are likely to maintain higher cash ratios than smaller firms.Consistent with existing studies, itis hypothesized that the size of firms operating in Zimbabwe’s multiple currency economy has positive influence on the corporate dividend policies and corporate cash holdings of these firms.
Firm Growth Rate:Firm growth rate is measured as annual sales growth rate. A number of previous studies found that corporate dividend policy is positively influenced by the growth rate (Ben Naceur, Goaied, & Belanes, 2006; Fama & French, 2001; Kania & Bacon, 2005). This means firms experiencing rapid growth in their sales are most likely to have higher dividend payout ratios than firms experiencing lower growth rates. However, Demirgünescedil (2015)found a negative relationship between firm growth rate and the firm’s decision to pay dividends. Based on this finding, the higher the growth rate, the less likely a firm is to pay dividends, as funds are needed to drive the high growth rate. The impact of growth rate on corporate cash holdings is reported to be positive (Martínez-Carrascal, 2010; Opler et al., 2001)as well as being negative (Kariuki et al., 2015). Thus, firms with higher growth rates can either maintain large or small amount of cash holdings according to these findings. Considering that Zimbabwean firms need to recapitalize their operations (Kwenda, 2015)and are operating in a liquidity constrained environment (Kwenda & Matanda, 2015), it is hypothesised that the growth rate of these firms may have no influence on their dividend and cash holdings policies.
Profitability:Profitability can be measured in terms of return on equity (ROE), return on assets (ROA) andoperating profit margin (OPM) (Ali & Yousaf, 2013; Hemmati, Rezaei, & Anaraki, 2013; Mehta, 2012). Profitable firms are likely to pay out more dividends than less profitable firms. A negative relationship exists between dividend policy and ROA (Mehta, 2012; Thu, Lê Vĩnh Triển, & Anh, 2013) while the relationship is positive between ROE and dividend policy (Uwuigbe et al., 2012). This means firms with higher ROA maintain lower dividend payout ratios while firms with higher ROE maintain higher dividend payout ratios. ROE and EBIT respectively positively and negatively influencecash holdings(Ali & Yousaf, 2013; Hemmati et al., 2013). Thus firms with higher ROE maintain higher cash ratios while firms with higher EBIT maintain lower cash ratios. In this study, it is been hypothesized that profitability positively influences both dividend and cash holdings policies.
Financial Leverage:Financial leverage is the extent to which a firm is financed by debt and is measured by dividing total debt with total assets (Thu et al., 2013). Higher leverage may result in a lower payout ratio as lenders put restrictive covenants in debt contracts. Al-Malkawi, Rafferty, and Pillai (2010) and Gupta and Banga (2010) found a negative relationship between dividend policy and financial leverage, meaning the higher the financial leverage ratio the lower the dividend payout ratio. However, Jensen (1986) found that firms with higher financial leverage ratios maintain high dividend payout ratios than firms with lower financial leverage ratios.In analysing the relationship between financial leverage and cash holdings, Al-Malkawi et al. (2010) and Anjum and Malik (2013) found that firms with lower financial leverage ratios keep large cash holdings than firms with higher leverage ratio. Islam (2012) and Kariuki et al. (2015) analysed the financial leverage and cash holdingsrelationship and found that firms with higher leverage ratios maintain lowercash ratios.The direction of influence on financial leverage on dividend and cash holding policies is difficult to hypothesize given the conflicting findings in existing studies.
Liquidity:Liquidity or working capital can be defined as total current assets excluding cash and cash equivalents divided by total current liabilities (Ogundipe, Ogundipe, & Ajao, 2012). Badu (2013) and Gupta and Banga (2010) reported that firms with higher liquidity ratios pay higher dividends than firms with lower liquidity ratios. A negative relationship is also confirmed between liquidity ratio and cash ratio, where firms with higher liquidity ratios are likely to have lower cash holdings than firms with lower liquidity ratios (Ali & Yousaf, 2013; Islam, 2012). However, Ogundipe et al. (2012) found that low liquidity companies maintain lower cash ratios than high liquidity companies. Accordingly, this study hypothesizes that liquidity significantly influences both corporate dividend policy and corporate cash holdings policy in a transitional economy.
Business Risk:Business risk can be defined as variability in cash flows or profitability (Mehta, 2012; Sher, 2014). Firms experiencing high business risks pay lower dividends while maintaining high levels of cash holdings (Opler et al., 2001; Sher, 2014). In this paper, it ishypothesised that business risk negatively influences cash holdings policy and positively influences dividend policy.
The above discussion confirmed that corporate dividend policy and corporate cash holdings are influenced by common factors. Furthermore, some studies established that dividend policy and cash holdings policy impact on each other (Gao, Harford, & Li, 2013; Tsuji, 2014). This confirms that there is a simultaneous relationship between dividend policy and cash holdings policy. A study by Al‐Najjar and Belghitar (2011) confirmed this simultaneous relationship and is the anchor of this study. The next section will discuss the data sources and analysis methods.
2.1Sample and data sources
This study aims to examine the dividend and cash holding policies employed by Zimbabwean listed companies and examine whether simultaneity between these two policies holds. The empirical study is based on a sample of non-financial firms listed on the Zimbabwe Stock Exchange. Sample firms’ data were collected from the financial statements for the accounting period 2009 to 2014 from the McGregor BFA Library. Consistent with some previous studies firms in the banking and financial services real estate sectors were excluded from the sample because they are highly leveraged and the nature of their cash holdings is different from the context of this study.
2.2Descriptive Statistics
The means values are used to measure central tendency for the variables while minimum value, maximum value and standard deviation measure variability in study variables. The average total annual dividends to profit after tax (DY) is 0.07 with a volatility of 0.17. The average cash and cash equivalents to total assets (CASH) is 0.06with a minimum of zero and a maximum value of 0.29. The average leverage (as measured by total debt to total assets) is 0.53 which means firms in this sample finance a little over half of their assets with debt. The average ROE is 6% which means that sample firms are generating 6 cents per every dollar invested by the shareholders. Sample firms are experiencing high growth in sales as shown by the average of 46%. The average non-cash liquid current assets to total assets (WCR) is 1.46 with a volatility of 0.89, a minimum value of 0.18 and a maximum value of 3.68.
3Methodology
The study follows the footsteps of Al‐Najjar and Belghitar (2011) in analyzing the determinants of cash holdings and dividends payments. The decision to pay dividends depends on cash held by the company and similarly, the decision to hold cash depends on the firm’s dividend policy.
Table 2: Descriptive Statistics
Variables / Variable construction / Mean / Standard Deviation / Minimum / MaximumDY / Total Annual Dividends / Profit After Tax / 0.07 / 0.17 / 0 / 0.8
CASH / Cash And Cash Equivalents / Total Assets / 0.06 / 0.07 / 0 / 0.29
SIZE / natural logarithm of total assets / 4.59 / 0.80 / 3.01 / 6.94
LEV / Total debt / total assets / 0.53 / 0.22 / 0.08 / 0.99
GR / Annual growth rate in sales / 0.46 / 0.66 / -0.73 / 3.64
ROE / Profit after tax / Total equity / 0.06 / 0.18 / -0.17 / 1.01
WCR / Total Current Assets – Cash & Cash Equivalents / Total Current Liabilities / 1.46 / 0.89 / 0.18 / 3.68
RISK / Variability in Return on Equity / 0.37 / 0.61 / 0.001 / 3.62
Source: Own calculations using an unbalanced panel over the period 2009 to 2014. Data obtained from the McGregor BFA library.
3.1Correlation Matrix
In this segment, the findings on the associations among the study variables at 5% significance level are given. The following Table 6.2 summarises the correlation results of the variables.
Table 3: Correlation Matrix
DY / CASH / SIZE / LEV / GR / ROE / WCR / RISKDY / 1.0000
CASH / 0.8699 / 1.0000
SIZE / 0.7860 / 0.8500 / 1.0000
LEV / 0.7084 / 0.8190 / 0.7437 / 1.0000
GR / -0.1991 / -0.1994 / -0.2541 / -0.1973 / 1.0000
ROE / 0.7888 / 0.7885 / 0.7488 / 0.6580 / -0.2046 / 1.0000
WCR / 0.7773 / 0.8361 / 0.7978 / 0.7607 / -0.2142 / 0.7403 / 1.0000
RISK / -0.6896 / -0.7107 / -0.6146 / -0.6943 / 0.0474 / -0.4773 / -0.6899 / 1.000
Source: Own calculations using an unbalanced panel over the period 2009 to 2014. Data obtained from the McGregor BFA library.
Table 3 presents the correlation values between dividend payout ratio (DY),cash ratio (CASH) and the explanatory variables.There is a strong positive correlation between dividend payout ratio andcash ratio suggesting that when firms increase their dividend payout ratios when their cash ratios increase.Pairwise correlation among independent variables; firm size (SIZE), financial leverage (LEV), firm growth (GR), return on equity (ROE), working capital ratio (WCR) and business risk (RISK) do not exhibit excessively high correlation; therefore the regression results will not have multi-collinearity problems.
3.2Single Equation Models
The study first performed regression to determine explanatory variables for both dividend policy and cash holdings policy, devoid of existence of simultaneity. The following models represent the single equation models: