CHAPTER ONE

INTRODUCTION

1.0 Introduction

The stock price is perhaps a variable which is volatile and sensitive to variety factors. While there are many variables that change significantly over the time, the change normally is uni-directional (Chee, 1996). However, stock price shows big changes over time and those changes can be in multi-directions, particularly in the short run. Thus, the investors as well as shareholders are started questioning and considering those factors as guidance in making the right call to invest which may get gain higher return. There are many factors that affect stock price volatility, which can categories into two aspects, external and internal factors. External factors can defined as uncontrollable variables that happen outside a firm; conversely, internal factors are firm characteristics that can be control by the management of firm. Economic situation, politic stability, and industrial condition become the primary external factors, whereas, firm's performance, earning per share and transparency are the internal factors that affected stock price movement. This study extends the knowledge of the stock price relationship by investigating the firm internal characteristic which influences it.

1.1 Background of Malaysia Stock Market

In the last decade, Malaysia economy was growing at average 8% annually. The market capitalization for Malaysia stock market, Kuala Lumpur Stock Exchange (KLSE), increased approximately from RM 132 billion in 1990 to RM 807 billion in 1996. However, KLSE has lost more than 60% of its market capitalization during the regional financial crisis in 1997-98. Malaysia managed to recover to some degree, and until 2006, the market capitalization was reached RM 848.7 billion. Again, investment in Malaysia has been falling almost 11% year by year for the past two quarters. This phenomenon is caused by the global economic crisis and Malaysia's political volatility too, which seems to be harming and deterring future investment opportunities. According to Deutsche Bank Group global chief economist, Dr Norbert Walter, improvement must be implemented by Malaysia on the investment environment if it wanted to remain a competitive economic force among other emerging market in the long run. However, firm must also take part too since firm internal characteristics are the factors that will influence stock market fluctuation. Both parties should make a concerted effort to improve investment environment in Malaysia.

1.1.1 The Historical Data for Kuala Lumpur Composite Index (KLCI)

Sources: Kuala Lumpur Composite Index from year 1985 till year 2007, http://www.tradesignum.com.

Chart above shows that the movement of the Kuala Lumpur Composite Index (KLCI) from year 1985 till year 2007. Kuala Lumpur Stock Exchange (KLSE) was in an unstable condition from year 1985 but the market started actively traded since year 1993 till year 1997. The Ringgit Malaysia was achieved at about RM2.50 per 1 US dollar at that period. However, at July 1997, Asian financial crisis was started in Thailand and overnight went on to slam into the economies of many Asian countries, which included Malaysia too. KLCI fell from above 1200 points to a low of about 270 points, whereas Ringgit value dropped from RM2.50 to RM3.80 per 1 US Dollar.

In year 2006 and 2007, KLSE just started become actively traded exchange in the market which achieved 1445 points at the end of year 2007. However, the US Subprime Mortgage Financial crisis which happened in July 1997 was slowly turns into a global crisis and this was affected KLCI dropped to 877 points in the end of year 2008. Mean that, again, Malaysia market sentiments are dampened and volatility after recover back from the financial crisis that happened in past decade. In sum, the volatility in Malaysia Stocks Market must be overcome by putting more efforts in build the confidence level of investors to invest in Malaysia market.

1.2 Firm Internal Characteristics and Stock Price Movement

Market risks, also call as systematic risks, which are the external factors that are not related to a property, but will influence investments in the market (Byrne and Lee, 2000). Market risks, for example, inflation, recessions, war, and high interest rate, are the risks that cannot be avoided by firms and shareholders.

Whereas, non-market risks are associated with an individual property's characteristics, which are caused by such random events such as lawsuits, strikes, marketing plan, and so on. Due to these events are random, the risks can be eliminated by diversification, which a bad event on firm will be offset by good event in another (Brigham and Houston, 2007). In principle, a careful or clever investor can avoid those unsystematic risks by study more on the firm before making investment.

Therefore, firm internal characteristics are categorized in non-market risk which can be avoided if investors are cautious. In this study, firm internal characteristics, which include earning per share and dividend policy will be discuss and investigate. There relationship between these two factors with share price movement is identifying in this paper too.

1.2.1 Earning per Share

In an efficient stock market, share prices would be determined primarily by fundamentals, which can be categories into two factors, an earning base - company's earning per share, and a valuation multiple - price / earning ratio (Ugboh, 2008).

It is fairly straightforward connection to prove that stock prices are somehow related to a company's earnings. Earning per share can be defined as the profit that a company made per share on the last quarter. Every company is mandatory to publish their quarterly report which states the earning per share of their company. This possibly is the most important factor that might decide the company health, thus, directly influence the buying tendency in the stock market resulting in increase the particular stock price.

High earning per share has always attracted attention from investors. If a company's earning per share is higher than the corresponding previous year, the reaction of investors might be positively. The effect is that the demand on that particular stock will increase, hence, the price of stock will rally upward too, and vice versa.

Gary (2009) concluded that a stock price's rises or falls is rely on the change in the market's perception of the stock's future earning and confidence of investors have that those earnings will be achieved. When a company's report shows that earning per share is lower than previous, this may indicate bad things to come for the company in the point of view among investors. This perception, whether rational or not, lowers investors' confidence in the company's future earning potential, directly, reflected in remarkable drop in company's stock price.

Furthermore, earning per share gives us about an idea how a company's share price compares to its earning. The company stock is undervalued if the price of stock is too much lower than the company's earning. This indicates that the company stock price has potential to rise in the future. On the other hand, if the stock price is too much higher than actual earning of the company, this mean that the stock is overvalued and the stock price will be fall at any point.

Earning per share is based on historical number. In other words, this is what the company has done in past. In fact of mind, last reported earning is generally considered a good indication of future performance, which may reflect on the movement of a stock price.

1.2. 2 Firm Dividend Policy

Dividend policy is the core component of a firm's overall financial policy. It is consists of a number of decisions regarding how the firm's distribute profits to their shareholders and it generally includes basic about the selection of dividend policy, dividend payout ratio and payout channel. In fact, dividend policy remains a source of controversy despite years of theoretical and empirical research, including one aspect of dividend policy: the linkage between dividend policy and stock price risk (Allen and Rachim, 1996). Paying large dividends reduces risk and thus influence stock price and is a substitute for future earnings (Baslkin, 1989).

A series of theoretical mechanisms have been suggested that may cause dividend yield and payout ratios to vary inversely with common stock price volatility. There include duration effect, rate of return effect, arbitrage pricing effect and information effect. For duration effect, it implies that high dividend stock means near term cash flow. If dividend policy is stable, high dividend stocks will have a shorter duration. According to Gordon Growth Model, high dividend will be less sensitive to fluctuations in discount rates and thus ought to show lower price volatility.

Firm's rate of return affect implies dividend yield and payout ratio matters. Both dividend yield and payout ratio reflect for the amount of firm projected growth opportunities. Similarly, a firm with low dividend yield and low payout may tend to be valued more on future investment opportunities, and thus, it exhibits price stability. However, if forecasting of profits from growth opportunities are less reliable, the firm with low dividend payout may faced greater price volatility too. In summary, stock price is more sensitive to the changes of estimation of the rate of return in long-term.

The information's affect implies the information on dividend policy. Managers know more about the firm's true worth than do the investors. Dividend announcement is the information that given by managers about their firm and allow the market to estimate the firm's current earning. Investors may have greater confidence on a firm with high dividend payout. As a result, stock price movement may happen each time the firm dividend payout ratio is announced.

Furthermore, agency cost argument proposed that dividend payment may reduce costs and increase cash flow. Payment of dividends motivates management to give up cash rather than investing on low cost capital or wasting it on firm inefficiencies. Mean that, a firm may choose to pay high dividend to their shareholders rather than invest in low return projects in order to reduce investment risk and increase their firm value.

Dividend payout policy could be inversely linked to growth and investment opportunities. Both the rate of return effect and duration effect assume differentials in the timing of the underlying cash flow of business. The arbitrage or information effect will be suggested after controlling the influence of growth.

1.3 Problem Statement

The investment from local and foreign investors in Malaysia is falling recently. This issue may lead to the slow economy growth since our country income is decreasing too due to the lower investment rate. The efforts to prevent this issue must be make in order to recover Malaysia economy by making improvement on Malaysia's capital investment market. In fact, the stock price fluctuation in Malaysia stock market is affecting the confidence of investors to invest. Thus, more plans must be implemented by both party, either Malaysia government or companies themselves, in order to gain investors' confidence. Government is concentrated on the external factors such as politic stability, economic situation, and market capabilities, whereas, companies are concentrated on firm internal characteristics that might influence stock price movement. Hence, this paper is conducted to study the internal factors that might influence the movement of stock price.

1.4 Objective of Study

The main objective of this study is to empirically examine the share price relationship with the firm internal characteristics, which include firm earning per share and dividend policy. The sample of this study is the servicing firms that listed on the main board of the Kuala Lumpur Stock Exchange (KLSE). Particularly, the study aims:

  1. To investigate whether a higher earning per share is lead to higher share price.
  2. To examine if the firm dividend policy measured, dividend yield is associated with the price of stock.
  3. To identify the relationship between share price movements, earning per share, and dividend policy.

1.5 Rational of Study

This study provides the understanding of the firm internal characteristics that might be affected firm stock price besides other external factors. The contribution of this study can be categorized in two ways, which are the significant and relevant of this study, especially to firms as well as investors.

Rom the perspective of firm, this study helps in create the awareness of the significance of firm internal characteristics that might influence the stock price. Sometimes, firm may be overlooking of the internal factors that will give impact on the stock price. Indeed, external factors such as stock market trading, market cap, global economy and so on, are the main impacts that influence stocks price the most, but, the internal factors also give risk on stock price too. Internal factors are controllable variables which firm can dominated on its. Improvement on firm's operation can be making by management based on the company internal factors which might affect the movement of stock price. For example, a company may actively influence their earning per share figure to achieve forecasted earning per share value. Strategies like sale of assets to boost revenues, and buy-back or dilution of shares to prevent takeovers can be implemented by firm in order to affect the price of stock. In sum, by indicate the significance of internal factors, efforts can be make in order to increase their company stock price, and thus, increase the profit of company.

On the other hand, from the perceptive of investors, this study provides the understanding of the linkages between the firm internal characteristics towards stock price. Before make an investment, it is imperative that investors familiarize with the company's fundamental status and performance. Firm's earning per share, profit and revenue must be study before invest. Obtaining a reliable forecast of earning is an important step in assessing value of the stock. The accuracy on the transparency in financial report must be identifying since there are unethical company that hide the fact of their firm's performance. More efforts are implemented in order to acquire the relevant and accurate information from a company.

1.6 Scope of the Study

The scope of the study covers the companies of service and trading sectors in Malaysia, which are listed on the main board of the Kuala Lumpur Stock Exchange (KLSE). 100 companies will be chosen as the sample of the study. Companies' annual report for year 2008 is used as sources of the data for this study.

CHAPTER TWO

LITERATURE REVIEW

2.0 Introduction

In global finance literature, the firm's value indicators are discussed since there are important to identify a firm's wealth and values. The firm's value indicators include firm's earning per share and dividend policy. These two variables are significant in influenced firm's share price volatility. The price volatility can be controlled by firms as well as investors if they understand the theoretical of those two variables.

In this chapter, the literature reviews which are related to the firm internal characteristics that might influence share price movement will be discussed. The linkages between firm's earning per share, firm's dividend policy and share price movement are presented in order to provide understanding towards the related studies. The reviews are categorized into subtopics which include: earning per share and share price volatility, dividend policy and share price volatility, earning per share, dividend policy and share price volatility, as well as the relationship between information asymmetries, dividend and earning announcement. The information asymmetries are cover the related theoretical which are agency cost, signaling models and free cash flow hypothesis.

2.1 Reviews on Earning per Share and Share Price

Earnings are the summary measure of firm performance produced under the accrual basis of accounting. According to Dechow (2002), his studies resulted that earnings' ability to measure firm performance, as reflected in stock return, and earning forecast may reflect the share price movement too. A firm with high earning per share may lead to the increases of its share price. Share price movement may happen when reported earnings reflect economic profits after announcement is made.

It's fairly straightforward connection to prove that stock prices are somehow related to a company's earnings. Firm's high earning per share has always attracted investors' attention. Investors act positively on the stock with high earning per share, thus, the price of particular stock will rally upward too due to the increased on the demand of that stock. However, the failure of market to form expectation of long run earning growth for an individual company may causes of excess volatility in stock prices (Bulkley and Harris, 2003). Similarly, the expectation of investors towards firm earning per share may reflect the firm's value, directly, caused the stock price movement.

Based on Suleimen and Pradeep (2002) studies, they found that there is an increase in price volatility at the time of earnings release. They also suggest that the variance of price change around new release is positively related to the amount of accurate information. In this sense, the earning is a measurer of the firm's performance, whereby investors will act positively if the high earning is announced. The higher price happened due to the high demand on that company share.

Ajinkya and Gift (1984) suggest that managers issue earnings forecasts to reduce unequal access to information about the firm. However, Sloan (1996) states that investors are fixated on earnings and do not fully process accruals information. When investors fail to incorporate earnings' information, the buying tendency in this stock would not improve. Therefore, the price of share is remain maintain and firm's value too.

Uddin (2009) was investigated the relationship between firm internal characteristics and share price movement in Bangladesh. His study result showed that there is a significant linear relationship between market price of stock, net asset value per share, dividend percentage and earning per share. The indicators of company profitability like earning per share and dividend policy must be used to determine a firm value. Share prices are rely on those indicators in which the high volume of those indicators may lead to the share price upward, and vice versa.

2.2 Reviews on Dividend Policy and Share Price

Before year 1980's, several stock market literatures viewed the present value of dividends to be main determinant of market return of stocks. According to LeRoy and Porter and Shiller (1981), they concluded that under assumption of constant discount factor, stock prices were too volatile to be consistent with the movement of future dividends. Wohar and Mark (2006) stated that the decomposition of stock price movement is very sensitive to real dividend growth too. However, Cochrane (1992) and Timmerman (1995) argued that stock price fluctuation can be explained by time-varying discount rates and future excess return. The founding make by Cochrane (1992) on the variability of excess return is to be more important than the variability of dividend growth.

Nishat and Irfan (2003) analyzed the dividend policy and stock price movement in Pakistan. Both the dividend policy measures, dividend yield and payout ratio, have significant impact on the share price movement. Besides, their finding result also supports the arbitrage realization effect, duration effect and information effect in Pakistan. The responsiveness of dividend yield towards stock price movement increased whereas payout ratio is having significant impact at a lower level if significance only.

A successful firm earns income. The income distributed to shareholders as dividends. Therefore, the relationship between firm's incomes (profitability) and dividend payout is investigated by Amidu and Abor (2006) in Ghana. They believed that dividend payout ratio provides firm with no generally accepted prescription for the level of dividend payment that will maximize share value. In this sense, share price movement is act inversely with the dividend payout ratio. Amidu and Abor (2006) believe is supported by the finding that they done in Ghana, in which their research result showed a statistically significant and positive relationship between profitability and the dividend payout ratio. Meanwhile, the hypothesis on the negative relationship between share price and dividend payout ratio is accepted too.

According Graham and Dodd (1951) And Gordon (1959), they argued that an increase in dividend payout lead to higher stock price (firm's value) and lower the cost of equity. However, some empirical showed the opposite position. Peterson (1985) reported that with high dividend payout ratio, high returns are required by firm's shareholder, and this is lead to lower share price. Baker, Powell and Veit (2002) have investigated the relationship between dividend policy, firm value and share price movement. They found that an optimal dividend policy strikes a balance between current dividends and future growth that maximize stock price. They also found that stock price volatility is low if dividend policy is stable.

The Miller and Modigliani (1961) model stated that dividend policy is irrelevant under perfect market condition. However, market imperfection such as tax rates, transaction costs, floatation costs and irrelevant investor's behavior might make the dividends decision relevant (Hughes, 2008). In this sense, financial decisions like dividends are related to value as they convey information about future profitability. The expectation towards firm's future profitability may influence the current share price stability which may lead to share price movement.

Moreover, the smoothing hypothesis suggest that the dividend decision is the result of past and current earning which manager adjusts firm's dividend payout to some target level. Meanwhile, the signaling hypothesis points out that dividend have predictive power for future earning and share prices (Goddard, McMillan and Wilson, 2006). In other words, there is a positive correlation between dividend, earning and share price. Dividend choices are linked to firm's future expected earnings, and dividend changes should signal futures earnings changes and prices changes too. This also supported by the result of the study of Goddard, McMillan and Wilson (2006) in which there is a strong evidence of a contemporaneous relationship between share prices, dividends and earnings for 137 United Kingdom manufacturing and service companies.

Amidu and Abor (2006) study suggest that, profitable firms tend to pay high dividend. The result also shows negative associations between dividend payout and risk. Firm which experiencing earning volatility find it difficult to pay dividend, therefore, the firm may pay less or no dividend to their shareholders. In this sense, the result points out the important relationship between dividend and earning, and this relationship might directly influence that movement of share prices. The firm may faced high share price volatility if the firm's earning volatility is affected the decrease of dividend payment.

Table 1: Summary of Related Studies on Earning per Share, Dividend Policy towards Share Price Volatility

Researcher

Methodology

Country

Findings

Uddin

(2009)

OLS Regression Model

Bangladesh

There is a significant linear relationship between Market Price of Stock and Net Asset Value per Share, Dividend Percentages and Earning per Share.

Nishat and Irfan

(2003)

Multiple Regression Model, Correlation

Pakistan

The dividend policy measures, dividend yield and payout ratio, have significant impact on the share price volatility. Besides, their finding result also supports the arbitrage realization effect, duration effect and information effect.

Amidu and Abor

(2006)

OLS Regression Model

Ghana

The result points out the important relationship between dividend and earning, and this relationship might directly influence that movement of share prices.

Abraham

(2005)

Data Collection, Miller Price Optimism Model

USA

She was found that the high expectation by individual investors immediately prior to the earning announcement resulting in share price volatility after firm earning announcement.

Basil

(2009)

Regression Analysis, Lintner Models

Jordanian

There is a positive relation between firm size and dividend policy. The smaller company might pay less dividends and faced higher price volatility, whereas, the larger company might afford to pay more dividends and faced lower price volatility.

Goddard, McMillan and Wilson

(2006)

VAR Framework

United Kingdom

There is strong evidence of a contemporaneous relationship between prices, dividends and earnings, and little evidence of independence between these variables.

Baker, Powell and Veit

(2002)

Focus Group

Nasqad

They found that an optimal dividend policy strikes a balance between current dividends and future growth that maximize stock price. They also found that stock price volatility is low if dividend policy is stable.

Dechow

(1994)

Multiple Regression Model, Correlation

New York

His studies resulted that earnings' ability to measure firm performance, as reflected in stock return, and earning forecast may reflect the share price movement too.

Suleiman and Pradeep

(2002)

OLS Regression Model

No specific country

They found that there is an increase in price volatility at the time of earnings release. They also suggest that the variance of price change around new release is positively related to the amount of accurate information.

2.3 Reviews on Firm Size and Share Price

Firm size variable has become one of the key variables in prior literature to explain how share price is volatile. Small firms are more likely to be less diversified in their business activities and there are less examine by investors. In nature, the information of small listed companies share could possibly be less informed and illiquid too. Thus, these types of firms are subject to greater price volatility. Similarly, this shows that firm size effects may result the share price volatility in stock market.

Moreover, firm size effect becomes a variable too in order to explain the decision of dividend pattern which may affect the share price. Basil and Khaled (2009) stated that there is a positive relation between firm size and dividend policy. They argued that large firms are more likely to be mature and easier to excess to capital market, thus, large firms should be able to pay more dividends. In other words, larger firms can afford to pay higher dividends compare to the smaller firms. Based on the research of Basil and Khaled (2009), they found that large Jordanian firms tend to be more diversified and less likely to be financial distress risk; therefore, those large firms in Jordanian are more able to pay dividends to their shareholder. Also, this relation is supported by the transaction cost theory of dividend policy and prior literatures (Gul and Kealey, 1999).

Yan and Zhao (2001) claimed that decision on dividend pattern is differ for each firm, in which small firms prefer stock dividend whereas large firms tend to choose cash dividend. The pattern of dividend is significant related to investors' preference because some of them prefer cash dividend rather than stock dividend. When dividend announcement is making and it is fulfill invests' preference, stock price volatility may happen. Apparently, firm size becomes a variable that probably may lead to share price volatility.

According to Nishat and Irfan (2003), the result of their research stated that firm size effect is negative during pre reform period (1981-1990), however, it was positive during reform period in Pakistan. They stated that the market in the stocks of small listed firms could conceivably be less informed, more liquid, and as consequence subject to greater share price volatility. In sum, the smaller company might pay less dividends and faced higher price volatility, whereas, the larger company might afford to pay more dividends and faced lower price volatility.

2. 4 Reviews on Debt and Share Price

Based on corporate finance theory, the rise on debt-asset ratios may lead to a greater rate of change in firm's value due to the unused debt capacity. Therefore, debt variable is predicted positively related to price volatility. This theory is supported by Mohamad and Assir (1993), in which their research result observed positive relationship between debt and price volatility was significant at 0.05 confidence level. As a result, the higher debt usage is lead to higher price volatility.

On the other hand, the correlation between dividend yield and payout ratio (dividend policy measurers) and leverage is negative in Nishat and Irfan (2003) research. This indicated that firms with higher levels of debt pay lower dividends and have low payout ratio. Mean that, firms with higher debt has higher volatility in its share prices.

Based on the Pani research, the result displays negative sign of debt-equity ratio implies the inverse relationship between debt and stock return. As a firm with high debt, then its value is going to be affected by stock return. A firm with low value is tending to be more price sensitivity. In other words, debt variable is subjects to be positively related to share price volatility.

Indeed, the creditors usually will limit the dividend paid by a firm so that firm can repay their debt on time. Therefore, the firms with high debt rate are tending to be lower their dividend payment. This fact is supported by prior studies in which the firms with higher financial leverage have a lower rate of dividend payment. When the firm has high debt ratio, low market value and lower dividend payout, this may lead to the higher price volatility. Clearly, there is a positive relationship between price volatility and higher debt structure firms, have shows that higher debt may lead to higher share price volatility

CHAPTER THREE

METHODOLOGY

3.0 Introduction

In this chapter, the methodology used in conducting this study will be discussed. The methodology that used in this research includes data collection, data analysis, conceptual framework and the research hypotheses. Secondary data are used in this study which is collected from various relevant sources such as Kuala Lumpur Stock Exchange (KLSE), Department of Statistical Malaysia, annual report of each firm, business and economic magazines and so on. The linkages between share price volatility, firm's earning per share, and firm's dividend policy is examined by using Ordinary Least Squares (OLS) regression model. Statistical Package for Social Science (SPSS) software will be used to analyze the collected data.

3.1 Conceptual Framework and Hypotheses

Chart below shows the relationship between the three main variables, which are share rice volatility, firm's earning per share and firm's dividend policy.

Figure 2: The relationship between share price volatility, earning per share and dividend policy.

The business fundamental is related to the factor that influences the price of stock. Generally, the movement of stock price is affected by investors' estimation on firm's earning per share. Firm performance is measure by using earning, and reflect in stock price, then, earning forecast may reflect share price movement too (Dechow, 2002). Earning per share figures can illustrate the degree to which a company net income is keeping pace with its capital structure. Similarly, earning per share is important factor for deciding the health of a company and it also influence the buying tendency in market, which may directly affect the movements of share price. Thus, a hypothesis on the relationship between earning per share and stock price is created as below:

H1: There is a negative relationship between stock price movement and firm's earning per share.

Dividend policy measures, which include dividend yield and payout ratio, are varying inversely with common stock volatility. Under assumption of constant discount factor, stock prices are fluctuated to be consistent with future dividends movement, and stock prices are sensitive to dividend growth too (LeRoy and Porter and Shiller, 1981, Wohar and Mark, 2006). Dividend payout policy could be inversely linked to growth and investment opportunities. In other words, a firm dividend yield and payout ratio may reflect future investment opportunities of a firm, and may directly affect the firm's share price movement. Besides, dividend announcement is tending to cause share price volatility too. Hence, in order to investigate the relationship between those variable, the second hypothesis is postulated as below:

H2: There is a negative relationship between firm dividend policy and share price movement.

Based on smoothing hypothesis, dividend decision is the result of past and current firm's earning which manager use to adjust firm's dividend payout. Also, signaling hypothesis states that dividend payout is use to predict firm's future earning and share price. Mean that, these two hypotheses are showed there is a relationship between firm's earning per share, dividend policy and share price. Therefore, in order to examine the relationship between those three variables, the third hypothesis is postulated as below:

H3: There is contemporaneous negative relationship between firm's earning per share, dividend policy and share price movement.

3.2 Empirical Model

3.2.1 Correlation

Correlation is used as the way to test how two variables, which are firm earning per share and firm price volatility, are associated with each other and how strong that association is. Besides, correlation between dividend policy and share price volatility is tested by using this method too. The correlation coefficient provides the direction of the relationship between these two variables, either positive or negative. If the probability of earning per share is increasing, then the probability of the firm price will increase too, and vice versa.

3.2.2 Ordinary Least Squares (OLS) Regression

On the other hand, multiple regressions will be used in order to examine the relationship between share price movement, firm earning per share and firm dividend policy. A multiple regressions enable simultaneous testing and modeling of multiple variables. In this study, independent variables, earning per share and dividend yield, and control variables, debt and firm's size, are tested against share price movement.

3.2.2.1 Independent Variables

There are three equation used to address the hypotheses. The test involved the dependent variable, P against two independent variables, which are EPS and DY. Thus, the first hypothesis (H1) is presented by following equation:

Pj = a1+ a2EPSj+ ej (1)

Next, the second hypothesis (H2) is presented by following equation:

Pj = a1+ a2DYj + ej (2)

Lastly, the third hypothesis (H3) will be addressed by following equation:

Pj = a1+ a2DYj + a3EPSj + ej (3)

P is share price, the dependent variable in the equation. Share price is calculated by using the annual range of stock price divided by the average of the high and low stock prices. The annual range of stock price is calculated by averaging firm's quarterly stock price in the year.

For independent variables, DY is dividend yield and EPS is earning per share. Dividend yield is calculated by summing all the annual cash dividends which have been paid to common stock holders. The sum is dividing by the average of market value of the stock in the year. Earning per share is calculated by divided firm's net income with firm's common share outstanding.

3.2.2.2 Control Variables

According to Baskin (1989), there is a negative relationship between both variables above in both equation (1) and (2). There are difficulties to specify on dividend policy variables because those variables are tend to influence by other factors. Firm size and debt are the variables that might influence the firm's decision on dividend policy. Based on the study of Basil and Khaled (2009), they have concluded that large firms are more likely to pay more dividends. Similarly, a large firm is facing lower share price movement. Whereas, Nishat and Irfan (2003) found that firm with lower levers of debt pay higher dividends. Hence, in order to solve the problems that occur in determined dividend policy, the three equations are modified as by adding two control variables, which are firm size and debt. The modified equations are show as below:

Pj = a1+ a2EPSj + a3SZj + a4DAj + ej(4)

Pj = a1+ a2DYj + a3SZj + a4DAj + ej(5)

Pj = a1+ a2DYj + a3EPS+ a4SZj + a5DAj + ej(6)

SZ is presented size which created in a form that reflects the order of magnitude in real term. The value of size is the average of firm market value of common stock over the period. DA represent debt variable. The debt ratio is calculated by summing all the long-term debt which with maturity more that a year to total asset.

For equation (6), the expectation is that DY, EPS and SZ variables is negatively related to PV, whereas DA variable is positively related to PV. Mean that, the increase of dividend yield, earning per share and size of a firm are associated with a decrease of price. Conversely, the higher firm debt will lead to the higher share price.

3.3 Data Description

In order to conduct a study on the relationship between stock price movement, firm earning per share and firm dividend policy, a variety of data is needed. Thus, all data of the firms that have been selected from the listed on Kuala Lumpur Stock Exchange (KLSE) for year 2008 has been taken for the purpose. The financial data like earning per share, dividend paid, total assets, net income and so one is taken from each firm annual report that published by the firm themselves. For price data, it has been taken from the announcement and other annual publication of KLSE.

Table 2: Description of Variables

Variables

Description

Share Price (P)

It is calculated by dividing the annual range of stock price with the average of the high and low stock price in the period.

P = Annual range of stock price

Average of high and low price

Earning per S hare (EPS)

It is calculated by dividing firm's net income with common share outstanding.

EPS = Net Income

Common share outstanding

Dividend Yield (DY)

It is dividend yield that measured by total dividend paid to ordinary share divided by average of market value of stock.

DY = Dividend paid

Average market value of stock

Debt (DA)

DA is debt variable that calculated by summing all the long-term debt to total assets.

DA = Long-term debt

Total assets

Size (SZ)

Firm's size is measured by the average of firm market value of common stock over the period.

CHAPTER FOUR

EMPIRICAL RESULT

4.0 Introduction

The empirical result of the relationship between price volatility, earning per share and dividend yield is discuss in this chapter. The analysis is conducted by using secondary data set of 100 companies in Malaysia trading and service sector which are listed in Kuala Lumpur Stock Exchange (KLSE). The sample period is within the year 2008. Several tests are carried out in order to examine the linkages between price volatility, earning per share and dividend policy. Those tests are included descriptive statistic, Pearson correlation as well as multiple Ordinary Least Square (OLS) regression analysis.

4.1 Result of Descriptive Statistic

The statistics of the price volatility, earning per share, dividend policy, debt and size for 100 Malaysian listed trading and service companies within the period of 2005 is presented in table 2. The total observations of all variable are the same, which are 100. In year 2008, the mean for price volatility is about 1.38. The maximum value of price volatility is 3.18, whereas, the minimum value is only 0.89. Then, the standard deviation for price volatility is 0.35.

On the other hand, the mean of independent variables, dividend yield and earning per share, are 2.80 and 0.21, respectively. The maximum value for dividend yield achieved 8.45, whereas the minimum value is equal to 0. This indicated that there are some companies do not declare dividend to its shareholders in that year. Then, the maximum value for earning per share is 1.40 while minimum value is -0.51. The negative sign for minimum value shows that there are companies making loss in their business. Lastly, the standard deviation for both variables is 9.09 for dividend yield and 0.26 for earning per share.

Moreover, the mean value for debt is around 0.13, maximum value is 0.81; minimum value equal to 0 and standard deviation is 0.15. The zero value for minimum shows that there are companies which do not involve in debt for that period. For firm's size, the mean value is 1.72. The maximum value of firm's size achieved 8.25, whereas the minimum value is 0.11. The standard deviation is about 1.91.

Table 3: Summary of Description Statistic

PV

DY

EPS

DA

SZ

Mean

1.37720

2.79760

0.21138

0.13348

1.72373

Minimum

0.88701

0.00000

-0.5140

0.00000

0.10750

Maximum

3.18182

8.45000

1.39890

0.80988

8.24750

Std. Dev.

0.35446

9.08646

0.26108

0.14847

1.90670

N

100

100

100

100

100

Notes: Table above shows the dependent, independent and control variables for 100 firms in trading and service sector in Malaysia, which are used in this analysis. PV is price volatility that calculated by dividing the annual range of stock price with the average of the high and low stock price in the period. DY is dividend yield that measured by total dividend paid to ordinary share divided by average of market value of stock. EPS refer to the earning per share which calculated by dividing firm's net income with common share outstanding. DA is debt variable that calculated by summing all the long-term debt to total assets. SZ is firm's size which is measured by the average of firm market value of common stock over the period. Std. Dev. is standard deviation whereas N is observation.

4.2 Correlation Matrix of Regression Result

The Pearson coefficients of all the variables that used in regression analysis are show in table 3. The result shows that firm's size has significant and positively relationship with earning per share at the 0.01 significant level. Also, firm's size is having significantly positive relation with dividend yield at 0.05 significant level. This result is same with the result of prior study that carried out by Basil and Khaled (2009), which they claimed there is a positive relationship between dividend yield and firm's size. However, firm's size has significant and negatively correlated with price volatility at the 0.10 significant level.

Besides that, the result shows that price volatility has insignificant and negatively relations with three variables, which include dividend yield and earning per share. This implies that the price volatility perform inversely with the changes of dividend yield and earning per share. If one of the variables decreases, thus price volatility will increase. On the other hand, price volatility also shown to be insignificant positively correlated to debt. Similarly, if debt ratio is increase, so does the price volatility.

From the result that obtained, it shows that debt has insignificant negative correlated with firm's size. There is no such strong relationship between debt and firm's size. Furthermore, dividend yield is shown to be insignificant and positively correlated with earning per share and debt. This result also demonstrates that dividend yield does not have a strong relationship with earning per share and debt. However, some previous studies have claimed that the higher debt ratio may bring to the lower dividend yield.

Table 4: Correlation Matrix of Regression

PV

DY

EPS

DA

SZ

PV

1

DY

-0.021

1

EPS

-0.156

0.119

1

DA

0.156

0.142

-0.090

1

SZ

-0.179*

0.212**

0.465***

-0.015

1

Notes: Table above shows Pearson coefficients of the variables that used in the regression for this study. PV is price volatility that calculated by dividing the annual range of stock price with the average of the high and low stock price in the period. DY is dividend yield that measured by total dividend paid to ordinary share divided by average of market value of stock. EPS refer to the earning per share which calculated by dividing firm's net income with common share outstanding. DA is debt variable that calculated by summing all the long-term debt to total assets. SZ is firm's size which is measured by the average of firm market value of common stock over the period. * means correlation is significant at the 0.10 level (2-tailed). ** means correlation is significant at the 0.05 level (2-tailed). *** means correlation is significant at the 0.01 level (2-tailed).

4.3 Multiple OLS Regression

Table 5, 6 and 7 present the empirical results for the multiple Ordinary Least Square (OLS) regression for the analysis of the relationship between share price movement, earning per share, dividend yield, firm's size and debt. There are two models for each table, in which model (1) is only tested dependent variable with independent variables, whereas, for model (2), control variables is tested together with independent variables against dependent variable.

The dependent variable for all models is price volatility (P). The independent variable for table 5 is earning per share (EPS) while for table 6, dividend yield (DY) is independent variable. Lastly, for table 7, both earning per share (EPS) and dividend yield (DY) are independent variables and share price is dependent variable. In addition, all equations are examined by adding two variables, which are firm's size (SZ) and debt (DA). Those two variables are used as control variables in order to identify their relationship between earning per share (EPS), dividend yield (DY) and share price (P).

The result from table 5 shows that earning per share is significant and negatively related to price volatility in model (1). Similarly, the finding suggests that earning per share has negative relationship with price volatility. Firm earning per share is reflects firm value, directly, it may caused the share price volatility (Bulkley and Harris, 2003). Therefore, we accept the first null hypothesis - (H1) at 99 percent confidence level. The result is remains the same when control variables are added in the model (2). Earning per share and firm size are significant and negatively related to price volatility, whereas, debt is significant and positively correlated with price volatility. For model (1), the R-squared value is about 0.164 with the mean of earning per share explain only 16.4 percent of the variation in the price volatility. However, for the model (2) with control variables, the value increases to 0.341 or 34.1 percent of the variance in price volatility.

Table 5: Result of Multiple OLS Regression for Equation (1) and Equation (4)

P

(Model 1)

P

(Model 2 )

Variable

Coeff.

t-Stat

Sign.

Coeff.

t-Stat

Sign.

EPS

-0.405

-4.387

0.000

-0.203

-1.734

0.086

SZ

-0.225

-1.924

0.057

DA

0.390

4.667

0.000

R-sq

0.164

0.341

Adj. R-sq

0.156

0.321

D-W

2.192

2.060

F

19.246

16.584

Notes: Table above shows the results of the regression models run with several variables. PV is price volatility, DY is dividend yield, EPS is earning per share, DA is debt and SZ is firm's size.

From table 6, the result presents that dividend yield is insignificant and negatively related to price volatility in model (1). Similarly, the result suggests that negative relationship between dividend yield and price volatility. Thus, we accept the second null hypothesis - (H2) at 99 percent confidence level. Then, control variables are added in the model (2), the result shows that dividend yield and firm size are significant and negatively related to price volatility, whereas, debt is significant and positively correlated with price volatility. A small listed firm could conceivably less informed, more liquid, and as consequence subject to higher share price volatility (Nishat and Irfan, 2003). For this model, the R-squared value is about 0.016 with the mean of dividend yield explains only 1.6 percent of the variation in the price volatility. However, when control variables are added in the model (2), the value increases to 0.368 or 36.8 percent of the variance in price volatility.

Table 6: Result of Multiple OLS Regression for Equation (2) and Equation (5)

P

(Model 1 )

P

(Model 2 )

Variable

Coeff.

t-Stat

Sign.

Coeff.

t-Stat

Sign.

DY

-0.127

-1.268

0.208

-0.219

-2.666

0.009

SZ

-0.387

-4.726

0.000

DA

0.426

5.187

0.000

R-sq

0.016

0.368

Adj. R-sq

0.006

0.348

D-W

2.372

2.169

F

1.607

18.596

Notes: Table above shows the results of the regression models run with several variables. PV is price volatility, DY is dividend yield, EPS is earning per share, DA is debt and SZ is firm's size.

Table 7 presents that earning per share and dividend yield are significant and negatively related to price volatility in model (1). The result suggests that negative relationship between dividend yield and price volatility. Therefore, we accept the third null hypothesis - (H3) at 90 percent confidence level. On the other hand, when two control variables are added into model (2), the result shows that earning per share, dividend yield and firm size are significant and negatively related to price volatility, whereas, debt is significant and positively correlated with price volatility. For model (1), the R-squared value is about 0.187 with the mean of dividend yield explains only 18.7 percent of the variation in the price volatility. However, when control variables are added in the model (2), the value increases to 0.387 or 38.7 percent of the variance in price volatility.

Since the computed value for Durbin Watson statistic for all models is between 2.06 to 2.38, the values are closer with the value of 2. Thus, this study is no either positive or negative first order autocorrelation in the error term within all regression equations. Hence, the safely infer can be make for this study.

Table 7: Result of Multiple OLS Regression for Equation (3) and Equation (6)

P

(Model 1 )

P

(Model 2 )

Variable

Coeff.

t-Stat

Sign.

Coeff.

t-Stat

Sign.

EPS

-0.415

-4.520

0.000

-0.196

-1.727

0.087

DY

-0.152

-1.662

0.100

-0.216

-2.653

0.009

SZ

-0.249

-2.193

0.031

DA

0.415

5.100

0.000

R-sq

0.187

0.387

Adj. R-sq

0.171

0.361

D-W

2.238

2.185

F

11.177

14.980

Notes: Table above shows the results of the regression models run with several variables. PV is price volatility, DY is dividend yield, EPS is earning per share, DA is debt and SZ is firm's size.

CHAPTER FIVE

CONCLUSION

5.0 Introduction

Discussion, conclusion and limitations of the study will be discussed in this chapter. The discussion part will be emphasized on the possible relationship between price volatility, earning per share and dividend yield. Next, follow by the discussion on policy and recommendations for this study. Lastly, the limitations on the study will be focus at the final part of the chapter

5.1 Conclusion

The main objective of this study is to empirically investigate the relationship between share price volatility and firm internal characteristics, which include firm earning per share and dividend policy. This study used secondary data of the 100 Malaysian service and trading companies which are listed on the main board of Kuala Lumpur Stock Exchange (KLSE). The time frame of this study is within the year of 2008. The linkages between share price volatility, firm's earning per share, and firm's dividend policy are studied in separate regression models, in which Ordinary Least Squares (OLS) regression analysis is used as the methodology in the study.

In examining the linkage between the price volatility and firm earning per share, the empirical results of OLS regression analysis demonstrates that earning per share is significant and negatively related to price volatility. This finding suggests that earning per share has negative relationship with share price volatility. Particularly, the result indicates that a higher earning per share will lead to higher firm performance and thus lower share price volatility.

As a regard to determine the dividend policy among Malaysian companies in service and trading sector, the OLS regression analysis shows the result of there is insignificant and negatively related to price volatility. Hence, the finding illustrates that the dividend policy that declared by company is negatively associated with share price volatility. Similarly, the finding suggests that share price volatility acts inversely with dividend policy, in which a stable and attractive dividend paid may lead to lower share price volatility.

On the other hand, the empirical result of OLS regression analysis on the relationship between share price volatility, earning per share and dividend policy presents that both earning per share and dividend policy have significant and negatively correlated with share price volatility. Apparently, the finding indicates that higher earning per share and dividend paid lead to the higher firm performance. Thus, lower the share price volatility.

As the control variables, firm size and debt have conversely result related with price volatility in all models. From the result of OLS regression analysis, firm size is significant and negatively related to share price volatility, in which particularly shows that larger firm negatively associated with lower share price volatility. However, the empirical result indicates that debt has significant and positively correlated with share price volatility. This means debt variable is positively associated with the higher share price volatility. Principally, we can infer that high debt will lead to high share price volatility.

5.2 Policy and Recommendations

Theoretically, there is a negative relationship between capital structure and firm performance; meanwhile, a firm with high level of debt ratio may not lead to high firm value. Unfortunately, the use of debt of Malaysian corporations has grown radically in the past ten years with the aims of development and economic growth. Indeed, the rise of debt may affect share price volatility, in which empirically result verifies that higher debt may lead to higher share price volatility. In order to solve this problem, firms may use optimal capital structure as the alternative. Optimal capital structure is the capital structure that can minimize firm's weighted of capital, and thus maximizes firm's value. Apparently, capital structure is an important management decision and the change of firm's capital structure gives important information to investors. The invertors perception towards a firm may lead to the change of it share price in which their investment may affect the share price volatility.

Besides, under capital structure, it is easy to alter debt level through convertible holders' conversion, which is known as convertible debt (Isagawa, 2000). The purpose to issue convertible debt is so that it will not be converted in state where debt may avoid manager from over-investment, whereas, conversion happens in states in which outstanding debt causes under-investment. At the same time, the problem of over-investment and under-investment can be solved. When these problems are solved, a better firm performance can be achieved, and therefore, stabilize the firm share price.

On the other hand, firms with high level of debt ratio may use corporate restructuring strategy to overcome the problem too. High level of debt ratio is negatively affecting the firm's stock performance, and thus caused high stock price volatility. Nevertheless, restructuring strategy enables firms to reserve their debt level. Restructuring help firms to address firm underperformance, changes in business strategy and policy, financial distress, and the information gap between firm and capital market (Gilson, 1998). By restructuring strategy, alternatives and actions can be carried out by firms after they have identifying their firm's problems.

Furthermore, there are academic literatures pointed that market react with the changes of corporate governance. Corporate governance mechanisms implemented by stakeholder to monitor, supervise, and manage corporation's insiders and management (Fleming and Welch, 2000). Undoubtedly, corporate governance has succeeded to catch a great deal of interests which is focuses the long-term relationship between management and investors. Good corporate governance serves to increase investors' confidence and attract them to invest and thus, stabilize share price with higher firm performance.

5.3 Limitations

There are limitations found in this study. Firstly, the sources of the data become one of the limitations. In this study, secondary data are used. The data collected are from different sources, such as Bursa Malaysia (KLSE), Department of Statistical Malaysia, annual reports for each firm and business and economic magazines. The secondary data that used might be calculated using different method due to the different sources. For example, the calculations for financial indicates like earning per share, debt ratio, net income and dividend yield are different for each firm. Hence, the output for each firm would be varying which these might be influenced the overall result of this study.

Furthermore, secondary data are interpretation of primary data. This means that primary data are more valuable than secondary data. Thus, the accuracy of secondary data is considered. The data collected might be not accurate and do not reflect the actual economic situation in each firm. Some firms may be limited the information by do not report their real situation in their annual reports. Therefore, the difficulties in analyzing data may be happen.

Besides, Statistical Package for Social Science (SPSS) software that used to analyze the data is inappropriate. In fact, SPSS is more suitable on social science studies and quantitative tests compare with financial studies. Thus, one of the limitations of this study is using SPSS as the tool to run the tests.

This study is only investigates the relationship between price volatility, earning per share, dividend yield, with the controllable variables, debt ratio and firm size by using Ordinary Least Square (OLS) regression. Actually, this study still can be extended by using Two-Stage Least Square (2SLS) and Three-Stage Least Square (3SLS) regression analysis, in order to further examination on the relationship between those variables.

On the other hand, the time frame for this study is only one year, which is year 2008. In fact, the price volatility variable value may be more accurate if the analysis is study based on few years. Therefore, another limitation of this study is the short time frame is applied.

Source: Essay UK - http://turkiyegoz.com/free-essays/economics/stock-price.php


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