Corporate dividend policy is one of the most debated topics in corporate finance. Many researchers have devised theories and provided empirical evidence regarding the determinants of a firm’s dividend policy. The dividend policy issue, however, remains still unresolved as due to the fact that there are so many variables depending upon the type of company, its financial conditions, its industry etc that no single formula could be applicable. Clear guidelines for an ‘optimal payout policy’ have not yet emerged despite the voluminous literature. We still do not have an acceptable explanation for the observed dividend behavior of companies.

During the last fifty years several theoretical and empirical studies have been done leading to mainly three outcomes:

1. The increase in dividend payout affects the market value of the firm.
2. The decrease dividend payout adversely affects the market value of the firm.
3. The dividend policy of the firm does not affect the firm value at all.

However, we can say that empirical evidence on the determinants of dividend policy is unfortunately very complex. Basis on which corporations pay out dividends to the share holders is still an unresolved puzzle. First prominent study that appeared in the literature of finance regarding dividend policy was that of Miller and Modigliani (1961) where they state that there are no deception in a perfect and a rational economic environment. This was the starting point for other researchers to explore dividend payout policy phenomena. Almost all researches that followed referred back to Miller and Modigliani (1961). Various researches were carried out by many researchers to explore the determinants of dividend payout policy, some of them focused on profitability, some on size of the firms, some on growth rate of the firm while others on agency costs. For example researches carried out by Nissim et el (2001), Brook et el (1998), Bernheim et el (1995), Kao et el (1994), and Healy et el (1988) found out a positive association between increase in dividend payout and future profitability. Kalay et el (1986) and Asquith et el (1983) found out that stock returns is positively associated with dividend changes. Sasson et el (1976) conclude that the payout ratio is positive association with average rates of return. On the other hand, studies of Benartzi et el (1997) and DeAngelo et el (1996) find no support for the relationship between future profitability and dividend changes.

On Other side most debated factor affecting dividend policy arguably is agency costs. Jensen (1986). Agency cost argument suggests that cost is reducing by dividend payments and cash flow Rozeff (1982). Researches carried out by Jensen et el (1992), and Lang et el (1989) supported this agency cost hypothesis, while others such as Lie (2000), Yoon et el (1995) and Denis et el (1994) found no support for this hypothesis.

Size of the firm is another factor which seems to have an impact of dividend payout policy. Firms larger in size are considered to have more ability to payout dividends to its share holders. Lloyd et el (1985), and Vogt (1994) pointed that firm size plays a role in clarifying the dividend-payout ratio of firms. They argued that because larger firms are mature and have easy access to capital markets thus they are not really much dependant on internally generated funding which enables them to payout higher dividends.

The purpose of this research is to investigate the dynamics and determinants of dividend policy of oil & gas sector firms in Pakistan. The independent variables selected from the literature include: market capitalization, profitability and annual rate of growth of total assets. Analysis of these variables should reveal there exist an impact of these variables on dividend payout policy of the firms and very nature of the relationship.

The remaining part of this thesis is organized as follows. In section 2 brief reviews of theories about the dividend will be presented. In section 3 of this thesis the data and possible variables that can act as proxy for different influences for analysis are discussed. Section 4 will provide details of methodology used. Section 5 thesis will establish analysis and interpretations and section 6 will present results and drawn a conclusion.

CHAPTER II

LITERATURE REVIEW

There are various theories which provide insight on how a firm pays the dividends.

2.1 Miller and Modigliani theory

According to Miller and Modigliani (of Merton Miller, Franco) (1961) dividend do not affect firms’ value in perfect market. Shareholders are not concerned to receiving their cash flows as dividend or in shape of capital gain, as far as firm’s doesn’t change the investment policies. In this type of situation firm’s dividend payout ratio affect their residual free cash flows, when the free cash flow is positive firms decide to pay dividend and if negative firms decide to issue shares. They also conclude that change in dividend may be conveying the information to the market about firm’s future earnings.

Example:

It’s a common believe that dividend policy is created by shareholder himself for example if a person has 10,000 PKR and wants income of 3,000 PKR a year from that portfolio, simply 3000 PKR money value can be sold by a person this amount as dividend income does not accept by him. This theory says, “Who is anxious about dividends?”

M&M explains that under certain assumptions including rational investors and a perfect capital market, the market value of a firm is independent of its dividend policy.

Smirlock & Marshall, (1983) stated that relationship between the Dividend and Investment Decisions indicates that no causality between the dividend and investment decisions of the firm. The fact that the firm-specific data conclusively supported the separation principle is particularly convincing. This is the first application of causality tests to a large sample of firms.

2.2 The bird in the hand theory

Investors always prefer cash in hand rather than a future promise of capital gain due to minimizing risk Gordon (1963).

Gordon believes that he is anxious about investing in dividends and dividend stocks. Gordon say that when he is paid hard cash by the company, he knows that the company is not just telling him that it is making money but the fact it that it is really making money . This is the idea that cash payment is valued by the investors for the hope of future profits.

2.3 The agency theory

Traditionally, corporate dividend policy has been examined under the assumptions that the firm is one homogenous unit and that the management’s objective is to maximize its value as a whole. The agency cost approach differs from the traditional approach mainly in this way that it explicitly recognizes the firm as a collection of groups of individuals with conflicting interests and self-seeking motives. According to the agency theory, these behavioral implications cause individuals to maximize their own utility instead of maximizing the firm’s wealth.

The agency theory of Jensen and Meckling (1976) is based on the conflict between managers and shareholder and the percentage of equity controlled by sponsor ownership should influence the dividend policy. The theory focuses on the relationship between an agent of the principal (company’s managers) and a principal (shareholder).

Jensen and Meckling (1976) in corporations, agency problem arise from external debt and external equity. Jensen and Meckling (1976) analyzed that how firm value is affected by the distribution of ownership between inside shareholders and outside shareholders who can consume perquisites, and who cannot. Within this framework, increased managerial ownership of equity alleviates agency difficulties by reducing incentives to consume perquisites and expropriate shareholder wealth. Jensen and Meckling (1976) argue that equity agency costs would be lower in firms with larger proportions of inside ownership. Managers are better understanding their interest with stockholders when they increase the shareholders’ ownership of the firm.

Dividends are plays an important role to r