Dividends, investment, and external financing behaviour of public limited companies in the engineering inndustry in India

Abstract

The interdependence between dividends, investment, debt, and equity financing has been studied within the context of both the single equation and simultaneous equation models using cross-section data on the Indian engineering industry for each of the three years 1969 - 70 to 1972 - 73. The prominent models of investment, dividends, and financing - 21 in all - were used in a modified form to include the interdependence among them within the context of single equation models and compared on the basis of the results obtained. The dividend model based on Britain抯 model, the liquidity accelerator model of investment, and finance models incorporating the desired changes in regard to financing were found to perform best among the various models tried and were chosen for two-stage least squares estimation of the equations of the model. The empirical results from both the single equation (OLS) and two-stage least square (simultaneous equation) estimates support the view that the dividend is a relatively autonomous decision variable and that it is rigid downwards, implying that the companies are reluctant to revise the dividends downwards. No support is found for the view, put forth among others by Higgins, that the dividends and new equity finance should be negatively correlated. The investment was found to be adversely affected by the dividend and working capital requirements. The results of the new equity and debt finance equations were found to be inconclusive. The dividends were found to have a significantly positive impact in 1970 and 1971- the period of upswing - on the new equity finance variable. The rate of return on capital employed was found to have a negative but insignificant impact on the external equity finance. The coefficients of the rate of return and the dividend variables jointly indicate that the dividends convey more information to the capital market than the rate of return. The estimates of the external debt equation were also unstable. No evidence was found in support of the target debt-equity ratio. The broad conclusion of the study is that, in the Indian context, the dividend decision is a comparatively autonomous one and that the investment decision cannot be made without taking into account the dividends and working capital requirements.