CHAPTER I

INTRODUCTION
1.1 Background of the Study Dividend policy for business organization is a very important decision, which depends upon the long-term and short-term strategy of a firm. Dividend policy of a firm is an effect of dividing its net earning into two parts: the retained earnings and dividend payment. (Pandey; 1999: 770) Business firms use the retained earnings to provide funds to the firm for long-term growth; we call it as internal financing source also. Dividend is that portion of earning, which is paid to the common stock holders, is a return on their investment. By a dividend policy we mean some kind of consistent approaches to the distribution versus retention decision rather than making the decision on the purely ad hoc basis from period to period. (Pearson, William & Gordon; 1972: 405) Likewise, dividend policy must be considered in relation to the overall financing decision. In practice, net earnings always may not be appropriate measure of the ability of the firm to pay dividend, that's why, what and how much it is desirable to pay dividend is always a controversial topic because shareholders expect higher dividend but companies ensure towards setting aside funds for maximizing the shareholders wealth. When a company pays out a portion of it's earnings to the shareholders in the form of dividend, the shareholders are directly benefited. If company is hopeful to exploit other growth opportunities, the firm can avoid for paying cash dividends. In this condition, shareholders consider their future growth of their stock instead of getting cash dividend. On the other hand, the firm has to pay enough dividends to satisfy investors. If they are paid higher dividends, the market price of the stock also rises. This means of maximizing the shareholder's wealth. Thus shareholders wealth (return) can be increased through either dividends or capital gains. As the division and retention are
1

considered as dividend policy, all aspects and questions related to the payment of dividends are contained in dividend policy. Financial institutions have definitely contributed and played a gigantic role for domestic resource mobilization and economic development to build up the confidence of the businessmen for promoting their business and industrialists for encouraging opening new business venture. It maintains confidence for various segments and extends credit to people. (Hastings; 1996: 72) The banking concepts and activities started in Nepal only after the establishment of Nepal Bank Limited in 1937. A central bank (Nepal Rastra Bank) was established to regulate the banking activities and, declare & implement monetary policy of the nation. Then after, it was realized that the commercial bank has its own role and contribution in the economic development. It is the source of economic development; it maintains economic confidence of various segments and extends credit to people. So, another commercial bank, Rastriya Banijya Bank was established on 1966. Capital market plays an important role in the economics development of a nation. But, in Nepal, the capital market is very small and developing slowly with disorganized. The Nepalese companies (especially government enterprises) have not been able to generate sufficient as compared to the organizations that are established and operated on public sector. Hence the government is not receiving dividends from public enterprises for several years. In the global perspective, joint ventures are the modes of trading through partnership among the nations and also a form of negotiation between various groups of industries and traders to achieve competitive advantages. Nepal's reform efforts in the financial sectors, begun in 1980's, when Nepal Rastra Bank eased entry restrictions and amendment of the Commercial Bank Act
2

1974. As a result, three banks namely, NABIL Bank Ltd, Nepal Investment Bank Ltd. and Standard Chartered Bank Nepal Ltd. came into operation prior to 1990s. In 1992, Nepal Rastra Bank adopted liberal outlook in permitting commercial banks to open. Then after, the financial liberalization really took place. Many more banks came into operation making the total number of the commercial banks to twenty five. Dividend practice in public corporations is still having problem for taking dividend policy. Thus, here neither corporation are able to generate sufficient earnings for dividend payment nor is the government expecting dividends, since it has been observed that dividend payment is practically a crucial problem of the public corporations. Corporation like Nepal Oil Corporation and Nepal Electricity Authority are not distributing earnings as dividend but total effort is focused on minimization of losing through better utilization of capital. Noticeable matter is that this shifting aim of public corporation is failed to minimize the losses. The joint venture banks in Nepal have brought new hope for productive mobilization of funds according to their new trends of dividend. Although, twenty eight commercial banks are in operation in the nation; only twenty one commercial banks are listed in security board, on the Nepal Stock Exchange. Out of which only five commercial banks have been taken as sample. They are as follows: a. Standard Chartered Bank Nepal Ltd. b. Nepal Arab Bank Ltd. c. Everest Bank Ltd d. Bank of Kathmandu Ltd. e. Himalayan Bank Ltd.

1.1.1 Profile of the Selected Banks a) Standard Chartered Bank Nepal Limited Standard Chartered Bank Nepal Limited has been in operation in Nepal since 1987. The Bank is an integral part of Standard Chartered Group having an ownership of 75% and the balance owned by the Nepalese public. The Bank is the largest international bank currently operating in Nepal. With 17 points of representation, 21 ATMs and more than 375 local staff, Standard Chartered Bank Nepal Ltd. is in a position to serve its customers through an extensive domestic network. In addition, the global network of Standard Chartered Group gives the Bank a unique opportunity to provide truly international banking services in Nepal. Standard Chartered Bank Nepal Limited offers a full range of banking products and services in Wholesale and Consumer banking. The Bank has been the pioneer in introducing customer focused products and services and aspires to continue to be a leader in introducing new products in delivering superior services. Corporate Social Responsibility is an integral part of Standard Chartereds ambition to become the worlds best international bank and is the mainstay of the Banks values. b) Nabil Bank Limited Nabil Bank Limited, the first foreign joint venture bank of Nepal, started operations in July 1984. Nabil was incorporated with the objective of extending international standard modern banking services to various sectors of the society. Pursuing its objective, Nabil provides a full range of commercial banking services through its 40 points of representation across the nation and over 170 reputed correspondent banks across the globe. Nabil, as a pioneer in introducing many innovative products and marketing concepts in the domestic banking sector, represents a milestone in the banking history of Nepal as it started an era of modern banking with customer satisfaction measured as a focal objective while doing business. Operations of
4

the bank including day-to-day operations and risk management are managed by highly qualified and experienced management team. Bank is fully equipped with modern technology which includes ATMs, credit cards, state-of-art, world-renowned software from Infosys Technologies System, Banglore, India, Internet banking system and Telebanking system. c) Everest Bank Limited Everest Bank Limited (EBL) started its operations in 1994 with a view and objective of extending professionalized and efficient banking services to various segments of the society. The bank is providing customer-friendly services through its Branch Network. All the branches of the bank are connected through Anywhere Branch Banking System (ABBS), which enables customers for operational transactions from any branches. Moreover, EBL was one of the first bank to introduce Any Branch Banking System (ABBS) in Nepal. In addition, EBL has introduced Mobile Vehicle Banking system to serve the segment deprived of proper banking facilities through its Birtamod Branch, which is the first of its kind. EBL has introduced branchless banking system first time in Nepal to cover unbanked sector of Nepalese society. EBL is first bank that has launched e-ticketing system in Nepal. EBL customer can buy yeti airlines ticket through internet. With an aim to help Nepalese citizens working abroad, the bank has entered into arrangements with banks and finance companies in different countries, which enable quick remittance of funds by the Nepalese citizens in countries like UAE, Kuwait, Bahrain, Qatar, Saudi Arabia, Malaysia, Singapore and UK. d) Bank of Kathmandu Limited Bank of Kathmandu started its operation in March 1995 with the objective to stimulate the Nepalese economy and take it to newer heights. BOK also aims to
5

facilitate the nation's economy and to become more competitive globally. To achieve these, BOK has been focusing on its set objectives right from the beginning. The bank targets to contribute to the sustainable development of the nation by mobilizing domestic savings and channeling them to productive area, to use the latest banking technology to provide better, reliable and efficient services at a reasonable cost, to facilitate trade by making financial transactions easier, faster and more reliable through relationships with foreign banks and money transfer agencies and to contribute to the overall social development of Nepal. Bank of Kathmandu Limited (BOK) has today become a landmark in the Nepalese banking sector by being among the few commercial banks which is entirely managed by Nepalese professionals and owned by the general public. e) Himalayan Bank Limited Himalayan Bank was established in 1993 in joint venture with Habib Bank Limited of Pakistan. Despite the cut-throat competition in the Nepalese Banking sector, Himalayan Bank has been able to maintain a lead in the primary banking activities- Loans and Deposits. Legacy of Himalayan lives on in an institution that's known throughout Nepal for its innovative approaches to merchandising and customer service. Products such as Premium Savings Account, HBL Proprietary Card and Millionaire Deposit Scheme besides services such as ATMs and Tele-banking were first introduced by HBL. All Branches of HBL are integrated into Globus (developed by Temenos), the single Banking software where the Bank has made substantial investments. This has helped the Bank provide services like Any Branch Banking Facility, Internet Banking and SMS Banking. Living up to the expectations and aspirations of the Customers and other stakeholders of being innovative, HBL very recently introduced several new products and services. Millionaire Deposit Scheme, Small Business Enterprises Loan, Pre-paid Visa Card,
6

International Travel Quota Credit Card, Consumer Finance through Credit Card and online TOEFL, SAT, IELTS, etc. fee payment facility are some of the products and services. HBL also has a dedicated offsite Disaster Recovery Management System. 1.2 Statements of the Problem Dividend is desirable for the shareholders, which inspires them for the further investment on company's shares. But it is found that there is no satisfactory result about dividend decision of commercial banks in Nepal. Likewise, dividend distribution does not match with the earnings of the commercial banks, there does not exist a proper relationship between dividend and quoted market price of share. Similarly, commercial banks with lower returns record stable (rigid) price of share and banks making sound returns do not rigid in share price. Dividend, the most inspiring factor for the investment on shares of the corporation, is an important aspect of financial management because the dividend policy determines the division of earnings between payment to stockholders and reinvestment in the firm to exploit growth opportunities. It affects the value of firm as well as overall financing decision such as financial structure, the flow of funds, corporate liquidity and investors satisfaction. The dividend decision, however, is still a crucial as well as controversial area of managerial finance. There is no consensus among the financial scholars on this subject matter and its relation with stock price. Some financial scholars say that stock prices are least influenced by dividend per share while some others believe that its relevance to the stock prices is quite significant. The idea of relevance is vague as well. It is rather hard to define whether dividend per share has positive effect or its effect is negative one. Thus for the study, the following research problems have been raised;
7

a) What is the situation of earning and dividend distribution of commercial banks of Nepal? b) What impacts do DPS and DPR and have on the MPS of the bank? c) Does the dividend yield and the joint effect of DPS and EPS changes the MPS? d) What will be the trend of DPS, DPR and MPS of the commercial banks in forthcoming years? 1.3 Objective of the Study The study primarily focuses on the dividend practices of commercial banks with a view to suggest ways to maximize the shareholders return, i.e. value of their investment is maximized. Followings are the specific objectives of the study. a) To analyze the earnings and the dividend distribution of the commercial banks. b) To examine the impact of DPS on MPS, and the effect of dividend payout ratio on the MPS, and the joint effect of EPS and DPS on MPS. c) To evaluate the relationship of dividend yield on DPS, EPS and MPS of the corresponding bank. d) To estimate the value of DPS, MPS and DPR for the forthcoming two fiscal years. 1.4 Significance of the Study Due to excess liquidity and lack of investment opportunities in the capital market, nowadays people are very much interested and attracted to invest in shares for getting higher returns. When any new company issues (floats) shares through capital markets, very big congregation gathers to apply for owner's certificate. It reveals that people have expectation on higher return for investing in shares. So the dividend decision is one of the most important decisions of financial management. It is an effective tool (way) to attract new investors, maintain present investors and controlling position of the firm.
8

Having lack of adequate knowledge, the people are haphazardly investing in shares. It shows that there is an extreme necessity to establish clear conception about the return that yields from investing in securities. In the Nepalese perspective, we find that there exist almost none of the companies adopting consistent dividend policy. There may be many reasons behind it. But there is not sufficient study conducted in this regard. Therefore, considering all these facts, the study is undertaken which will help to meet deficiency of the literature relating to dividend practice and price of stock. So this study is of considerable importance. So many persons and parties such as shareholders, management of banks, financial institutions, general public (depositors, prospective customers, investors etc.) and other policy making bodies which are concerned with banking (especially NABIL Bank Ltd, Standard Chartered Bank Ltd., Everest Bank Ltd., Bank of Kathmandu and Himalayan Bank Ltd.) business will be benefited from this study. It is also believed that it will provide valuable inputs for future research scholars. 1.5 Limitations of the Study The limitations of the study are as follows: a) The accuracy of secondary data depends on the reliability of the annual reports of the concerned banks. b) The study is focused only on dividend practice, earning and price of stock only and does not cover the other financial aspects. c) Only five banks are taken as samples to fulfill the objectives of the study. d) This study covers five fiscal year period only, i.e. from 2004/05 to 2008/09. e) Limited time and resources are also constraints.

1.6 Chapter Scheme The study has been organized into five chapters; Chapter I: Introduction It consists of background of the study, statement of the problem, objectives of the study, significance of the study and limitation of the study. Chapter II: Review of Literature It includes a discussion on the conceptual framework on dividend and its practices. It also reviews the major studies relating with dividend decision of several authors/researchers and from the several books, journals and article, and thesis. Chapter III: Research Methodology It explains the research methodology used to evaluate dividend practices of commercial banks in Nepal. It consists of research design, population and sample, source of data collection, method of analysis financial tools and statistical tools used in the analysis. Chapter IV: Data Presentation and Analysis Chapter four fulfills the objective of the study by presenting data and analyzing them with the help of various statistical tools as per methodology. It is concluded with the findings of the study. Chapter V: Summary, Conclusion and Recommendations It states summary, conclusion and recommendation of the study based on the data presentation and its analysis using the tools used in the analysis. Besides these chapters, Bibliography and Appendix are also included at the end of the study.

10