The Empirical Relationship between Dividend and Investment

Abstract

The article studies the determinants of two important decisions for the Indian firms—dividend and investment. In contrast to the Miller and Modigliani (1961) model, in which dividend decision is separable from its investment decision, the article finds evidence to support the argument that Indian firms adjust their dividends to accommodate investment, as proffered by Myers’ pecking order model (1984). Interestingly, the article also finds evidence in favour of the proposition that firms adjust their investment decision to accommodate dividends as well. Further, as observed in the literature, the results presented in the article are also consistent with the Lintner (1956) model which predicts that dividends move consistently towards target payouts. However, in contrast to Lintner’s single factor (i.e., earnings) target payout model, we find evidence in favour of multiple factors, such as, agency conflict, asymmetry of information and growth factors, to influence the optimal dividend decision.