Impact of financial leverage on dividend policy: Empirical evidence from Karachi Stock Exchange-listed companies

Abstract

This paper examines the relationship between dividend policy and financial leverage of 403 companies, listed with Karachi Stock Exchange during the period 2002 to 2008. Dividend policy, vastly followed by the companies, was tested by applying the extended model of Linter (1956) with the debt ratio of the firm, the previous year’s dividend yield as its independent variables and change in earnings as a dummy variable. At first, the descriptive statistics for our entire variables were calculated and then correlation matrix was calculated to identify the preliminary relationship among all the variables, followed by regression analysis on panel data to examine the significance and magnitude through fixed and random effects models. Theoretical assertions were justified through random effect model that the level of corporate debt (leverage) and widely practiced dividend policy, significantly, affect the dividend policy of the Pakistani firms. On the other hand, financial leverage was found to have a negative impact on dividend payout, indicating less dividend payments by high-debt firms. The findings also revealed/ confirmed that change in earnings has no significant impact on dividend policy in case of Pakistani firms while the dividend yield has positive impact and vice versa. Fixed effect model, applied for the study, supports only the significant effect of dividend yield on dividend per share.