On Choosing an Optimal Dividend Policy in India: A Test of Substitution Hypothesis, 1999–2016

Abstract

We aim to highlight quantitative significance of share buyback in an emerging economy, India by documenting its emergence and trends in stock over time, 1991–2011. The market reaction to the impact of stock repurchase program and dividend increase announcements on share price behavior and their relative signaling power with reference to Indian firms is empirically tested. Further, the problem at hand is to provide insights to what are the determinants of the choice between increasing dividends and utilizing an open market stock repurchase and the impact of that choice on the stockholders’ wealth position in India. The analysis is conducted from two points of view. First, we investigated how the market perceives and reacts to announcements of cash distribution method through dividend increase and to share repurchase. Second, we looked into what determinates corporate payout policy when marginal disbursements could be done with either dividend increase or stock repurchases. Some evidence is provided to reject the null hypotheses that managers do not discriminate in their choice of a payout method. Dividend paying and stock repurchasing firms display significant differences in firm characteristics. Further, firms do not appear to randomly choose between the various disbursements choices. Though weakly, our results suggests that large firms like to substitute repurchases for dividends.