Effects of Inflation on Dividend Payments: An Empirical Study of Public Companies in Hungary

Article excerpt

This paper examines dividend policy issues in Hungary. The results reported in this study suggest that dividend signalling is not of any relevance. However, there are clear signs for dividend smoothing. Thus, managers in Hungary seem to fear the need to cut or omit dividends and therefore try to avoid the dividend reductions in the nearer future by only gradually increasing dividend payouts as a reaction to rising corporate profits. Moreover, the empirical evidence reported in this study does give support to the assumption that the negligence of inflation can distort tests for dividend smoothing and dividend signalling.

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In spite of many research efforts there still at best is an imperfect understanding of the fact that managers seem to assign some importance to the formulation of the dividend policies of their firms. Different approaches have been suggested to explain why firms do pay dividends. However, examining the numerous empirical studies that do exist gives no clear picture. Recently, it has been argued that the negligence of inflation could be one explanation for the observation that there is no indubitable empirical evidence supporting specific theories of dividend determination (see Basse (2009) and Basse et al. (2011)). Meanwhile, this point of view has become quite popular. However, Basse and Reddemann (2011) have argued that additional empirical research examining data from emerging economies could be of interest because inflation rates in these countries tend to be more volatile. Therefore, this study analyses dividend policy issues using data from Hungary - one of the leading emerging markets in Eastern Europe.

Literature Review

In a widely cited paper Miller and Modigliani (1961) have argued that the dividend policy of a firm is irrelevant. They assume that the investment policy of the firm is given, that capital markets are perfect and that taxes do not exist. Under these circumstances higher dividends simply result in lower capital gains and the dividend policy of a firm is therefore without any economic relevance - at least when investors do not prefer dividends to capital gains or vice versa. This dividend irrelevancy hypothesis creates some problems for financial economists trying to explain why dividends do exist. In fact, there seems to be a dividend puzzle because it can be observed that numerous firms in many countries regularly decide to pay dividends (e.g., Black (1976) and Mann (1989)). Accepting the dividend irrelevancy hypothesis it should be a major surprise that managers generally seem to believe that it is of some importance for their firm to follow an appropriate dividend policy. Brav et al. (2005), for example, have used survey and field interviews documenting the special importance U.S. managers assign to the payout policy of their firms.

Corporate finance theory has made some suggestions for the relevance of dividends. These approaches to explain why managers decided to pay dividends usually are based on agency theory. The management of a firm is not necessarily acting in the best interest of the owners (see, for example, Stulz (1990) and Gugler (2003)). In fact, it is quite common to argue that dividend payments lead to a reduction of free cash flow and thereby force the management of a firm to obtain capital from external sources more frequently when new investment projects have to be financed. Trying to raise new capital forces a firm to give information to investment bankers, prospective investors and other economic agents reducing agency costs.

Moreover, dividend changes can help to overcome information asymmetries. According to the so-called dividend signalling theory managers do adjust dividends to signal changes to expected future earnings to financial markets (e.g., Asquith and Mullins (1986) and Denis et al. (1994)). This approach seems to be the most popular explanation for the existence of dividend payments. …


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