TESTING PECKING ORDER THEORY ON DIVIDEND PAYOUT RATIO IN GHANA
Date
2012-07-10
Authors
DOKU, ISAAC
Journal Title
Journal ISSN
Volume Title
Publisher
University of Ghana , Legon
Abstract
The Pecking Order Theory (POT) suggests that firms prefer internal over external sources of
financing investment. For external sources of finance, firms prefer the use of debt before equity
to finance investment. However, the POT did not show how the capital structure decision of
firms influences their dividend decision. POT can be combined with Lintner’s dividend model to
generate some predictions for financial leverage. This leads to the conclusion that when firms are
faced with earnings shortage, firms will borrow to pay dividend at the expense of profitable
investment. This means there will be a positive interaction between financial leverage and
dividend payout ratio, and a negative interaction between financial leverage and investment. The
theory further predicts that as firms make more profit, they would demand less debt representing
a reduction in financial leverage. The predictions of the POT where made based on data from
developing countries. However, due to differences in accounting and auditing practices between
developed and developing countries, these predictions might not hold in developing economies.
A cross sectional analysis was implemented on 33 out of the 34 listed firms on the GSE for the
period 2004-2009, employing both the 3SLS and OLS technique to test the predictions in Ghana.
The findings indicate that there is a positive significant interaction between financial leverage
and dividend payout ratio among listed firms in Ghana. The results further indicate that
profitability has the predicted negative influence on financial leverage, indicating that the POT
explains dividend payout ratio in Ghana. The results did not show any significant
interrelationship between financial leverage and investment, and between investment and
dividend payout ratio among listed Ghanaian firms. The results also show that dividend payout
ratio in Ghana is very low, therefore, policymakers should strengthen and enforce laws on
dividend payment in Ghana