Academic journal article International Journal of Business

On the Dynamic Interaction between Dividend and Investment Decisions: Evidence from Tunisian Listed Firms

Academic journal article International Journal of Business

On the Dynamic Interaction between Dividend and Investment Decisions: Evidence from Tunisian Listed Firms

Article excerpt

(ProQuest: ... denotes formulae omitted.)


For several years, financial economists have paid considerable attention to the relevance of financial decisions to maximizing shareholders wealth and firm value (Modigliani and Miller, 1958 and 1961). This resulted in a proliferation in theoretical proposals and their empirical validation (Myers, 1974; Black, 1976; Jensen, 2002). However, among this growing trend, relatively little research has focused on explaining the potential links between investment and dividend decisions. Financial theory in the tradition of Irving Fisher usually supposes possible investment opportunities program, as offered by the company to be known in advance. In terms of behavior, investment decision is considered as fundamental in the Investment- Dividend-Financing sequence. In this context, dividend decision is of secondary importance. Higgins (1972) obtains results on American companies, which support this view: dividends were a function of profit and investment, but investment did not depend on dividends. According to Lintner (1956, 1962, and 1964), decisions on dividends, investment and financing are determined mutually and are highly interdependent in the business. Walter (1956) considers dividend policy as a residual decision determined by investment opportunities. For Miller and Modigliani (1961), dividend policy does not matter and does not affect shareholder wealth. Thus, firm value only depends on the long-term real decision.

Several other studies focused on the relationship between investment and dividends without the perfect market hypothesis. The results are far from unanimous and are rather contradictory. Thus, the conclusions of some authors led to the absence of a relationship between these decisions (e.g., Fama, 1974; Higgins, 1972), while others pointed to a significant interaction between investment and dividends (e.g., Dhyrmes and Kurz, 1967). Under agency conflicts hypothesis, dividends may help reduce agency costs associated with the separation of ownership and control. Easterbrook (1984) argues that dividend payments force managers to raise funds in the financial markets more frequently than they would without paying dividends. On the other hand, and according to Jensen (1986), the existence of a discretionary fund (FCF) can be a source of conflicts of interest between shareholders and managers. Indeed the latter tend to increase the firm size by investing all free cash flow and accepting risky projects. In this context, dividend decision can be a way of reducing these discretionary funds, which are at the disposal of the manager, and subsequently mitigating over-investment risk.

Galai and Masulis (1976) introduce the hypothesis that dividends transfer wealth between bondholders and stockholders by reducing the value of debt holders claims. In equilibrium, debt holders optimally protect their interest by placing restrictive covenants on disposition of assets and dividend payments. Jensen et al. (1992) tested managerial financial decisions in a simultaneous system. They found that Leverage and dividends appear to be chosen simultaneously to decrease agency costs. However, they found no evidence that insider ownership is a substitute for Leverage and dividends in controlling agency costs. Born and Rimbey (1993) offered some empirical evidence inconsistent with the Easterbrook's (1984) hypothesis. DeFusco et al. (2014) examine the long-term dynamic relationships between investment, earnings and dividends for US firms observed over the period 1950-2006. Using impulse response functions and variance decomposition, they showed that investment and payout correlate in both the short and the long run via earnings. Hussain and Ahmed (2015) show investment and dividends have bidirectional causality. Profits are more allocated towards paying dividends rather than making investment.

In this paper, we will analyze the nature of the interaction between investment and dividend decisions using simultaneous equations in the absence or in the presence of agency conflicts. …

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