Proceeding of International Conference on Contemporary Management - 2015 (ICCM-2015), pp 01-11

VALUE ADDED (VAT), GROSS DOMESTIC PRODUCTION (GDP) AND BUDGET DEFICIT (BD): A CASE STUDY IN .

Anojan,V

ABSTRACT The focus of this study is to find out the impact of Value Added Tax (VAT) on Gross Domestic Production (GDP) and Budget Deficit (BD) of the country and also identify the association among value added tax, gross domestic production and budget deficit in Sri Lanka. Every country needs adequate for their successful economic activities of their country. The tax revenue can be divided into two major categories such as direct and revenue. Imposing the tax revenue is directly link with gross domestic production and budget deficit of the country. The indirect generally impose on production, turnover, distribution of goods and services so indirect taxes directly link with gross domestic production of the country. Value added tax is one of the major indirect tax revenue of the Sri Lanka which was introduced in 2002 (Central Bank Report). Regression and correlation analysis were performed in this study with the help of SPSS latest version. Regression results confirmed that there is (R2 = 0.866) significant impact of value added tax on gross domestic production of the country and also there is (R2 = 0.705) significant impact of value added tax on budget deficit. Correlation results confirmed that there is (P = 0.000) significant association between value added tax and gross domestic production and also there is (P = 0.002) significant association between value added tax and budget deficit of the country. It implies that the Sri Lankan Government should give key focus on amending and implementation of VAT because the county is facing the budget deficit continuously and here the gross domestic production impact by VAT same time VAT impact on BD of the country. Also the high level of GDP needs for every country to improve the BD of the country so the government has to handle the value added tax very carefully for the economic success of the country.

Keywords: Budget Deficit, Gross Domestic Production, Sri Lanka and Value Added Tax,

Department of Accounting, Faculty of Management Studies and Commerce, University of Jaffna, Sri Lanka. [email protected] 01 1. INTRODUCTION generally can be divided in to two major categories such as divided in to two major revenues such as tax revenue and indirect tax revenue. revenue and non-tax revenue. Tax revenue Tax revenue contributes more than 85% to plays an important role in the tax revenue of total revenue of the country. More than 80% the country especially more than 85% of tax revenue comes from indirect tax revenue of the country comes from the tax revenue and the remaining part contributes revenue in Sri Lanka. This study covers by the direct tax revenue. Here the Value value added tax, gross domestic production Added Tax (VAT) is one of the major tax and budget deficit of the country. Value under the direct tax revenue as well as added tax is one of indirect tax in Sri Lanka (IT) is the major tax under direct which was introduced in 2nd August 2002, tax revenue of the country. Singh (1999), due to this purpose goods and service tax Shanmugam (2003), Lymer and Oats (2009) abolished on the same date. pointed in their study that the main objective of imposing certain taxes on the public is to Taxation is one of the important generate revenues for the government for elements in managing national income, public expenditure. However Lymer and especially in developed countries tax Oats (2009) suggested, taxes are needed to revenue is playing an important role in reduce inequalities through a policy of civilized societies since their birth thousands redistribution of income and wealth so that years ago (Lymer and Oats, 2009). income gap between the rich and the poor is not as significant. Lymer and Oats (2009) stated that tax is defined as a compulsory levy or payment, Tax systems are also designed for social imposed by government or other tax raising purposes, such as discouraging certain body on income, expenditure, or capital activities which are considered undesirable assets, for which the taxpayer receives and protecting the environment. For nothing specific in return. However tax instance, the taxes on alcohol and payers are enjoying some advantages as tobacco are (at least partly) exercised to indirectly such as free health, free education, decrease consumption and thus encourage a nation defense, infrastructure facilities, healthier lifestyle. Taxes are also expected to etc… Income tax was introduced very firstly ensure economic goals through the ability of in England (UK) in 1799. In Sri Lanka the taxation system to influence the income tax was introduced under colonial allocation of resources including system in 1932. The first year of assessment transferring resources from the private (Y/A) was started from 1931. 1931/1932 is sector to the government to finance the the first year of assessment in Sri Lankan tax public investment programme, the direction system. Sri Lankan tax revenue can be of private investment into desired channels

02 through such measures as regulation of tax Research Questions rates and the granting of tax incentives. In  RQ1: Does VAT impact on GDP of the addition, import duties could be used to Sri Lanka? protect local industries from foreign  RQ : Does VAT impact on BD of the competition. This has the effect of 2 Sri Lanka? transferring a certain amount of demand  RQ : Is there any association among VAT, from imported goods to domestically 3 produced goods. Sri Lankan government is GDP and BD of the Sri Lanka? often doing varies changes in value added in the budgets according to the 3. SIGNIFICANCE OF THE STUDY economic needs of the country. Especially This research attempted to evaluate and government announced value added tax' analyze the impact of VAT on GDP and BD. registration threshold as 15 million LKR Every government has to increase turnover or production from 1st January 2015 government revenue and try to reduce and the government has reduced value added unnecessary government's expenses to to 11% as well. reduce the budget deficit here tax revenue plays a vital role in government revenue. 2. STATEMENT OF THE PROBLEM Specially value added tax contributes very highly to tax revenue. Further the There is a problem in Sri Lanka which government can be able to reduce the budget is, Sri Lanka is facing the budget deficit deficit through increasing gross domestic continuously also the government is doing production of the country. Even though several actions to reduce the budget deficit value added tax directly imposing through increasing tax revenue, increasing production of the goods and services and gross domestic production of the country turnover so government has to consider however they are unable to reduce the budget when they imposing value added tax on deficit. Sri Lanka had budget deficit 488,967 productions and turnover to manage the million LKR as well tax revenue 845,297 value added tax revenue and gross domestic million LKR (Central Bank Report 2012) in production of the country because both are 2012. Here proportion of the tax revenue and key important elements in economic budget deficit is 1:0.578, it is not good shine position of the country. for any country and especially to Sri Lanka because it is one of the developing country. The government has to take necessary steps 4. RESEARCH OBJECTIVES to improve gross domestic production and The main objective of the research was, tax revenue of the country to reduce the to find out the impact of value added tax on budget deficit of Sri Lanka. gross domestic production of Sri Lanka, the following objectives were considered as sub objectives.

03  To reveal the impact of value added tax scope for raising extra tax revenues, as a on budget deficit of the country. result of Non-compliance with corporate  To find out the relationship between persons result from technicalities and tax value added tax, gross domestic avoidance, poor record keeping and cash production and budget deficit of Sri transactions. Keen and Mansour (2010) Lanka. pointed that in analyzing the revenue  To suggest the possible recommen mobilization in sub-Saharan-Africa seen - dations to government of Sri that, within sub- Saharan Africa, revenue Lanka. performed more strongly in resource-rich countries. Desai, Foley and Hines (2004) 5. SCOPE OF THE RESEARCH noted that governments have at their disposal The researcher considered value added many tax instruments that could be used to tax revenue, gross domestic production and finance their activities such as recurrent and budget deficit of the Sri Lanka. The research capital expenditure. These tax alternatives aims to analyze and find out impact of value include changes in tax policy by the way of added tax revenue and its impact on gross changes in personal and corporate income domestic production and budget deficit of taxes, taxes on sales and services as well as Sri Lanka. The past ten years central bank manufacturing, value added taxes, capital reports (CBR) from 2004 to 2013 of the Sri gain taxes and others. It is not uncommon for Lanka used in this research to collect a country to impose all of these taxes evenly. necessary data for the study. Lim (1983) in this study of instability of government revenue and expenditure in less 6. LITERATURE REVIEW developed countries observed that tax There are very few studies which have revenues instability was the major cause of been conducted in the field of taxation expenditure instability in less developed however there are some of the relevant countries in the period going from 1965 to related studies with regard to the subject 1973. Bleaney, Gemmel and Greenaway matter were reviewed below. Expert of group (1995) also stated tax revenue instability, United Nations (2000) stated that there is the with particular reference to sub-Saharan need to streamline a nation tax system so as Africa analyzed the sources and the to ensure the realization of consequences of revenues instability in revenue through equitable and fair developing countries. They found that tax distribution of the tax burden. The stark revenue instability is more common in poor, reality in most developing countries is that more open and more inflationary economies. whilst there is severe budgetary pressure as a One of the earlier studies by Marsden (1983) result of ever increasing demand for stated that change in tax policy will affect the government expenditure, there is a limited economic planning and Gober and Burns (1997) pointed a countries economy may be

04 affect differently due to any tax policy 7. HYPOTHESES changes in each tax components. Mahdavi H1: There is a significant relationship (2008) revealed that the effect of rises in total among value added tax, gross domestic tax revenue will reduce the growth in production and budget deficit. developing countries. Due to by the fiscal H2: There is a significant impact of value crisis and tax policy changes in the past added tax on gross domestic production several decades, several developing of the country. countries had to revive its economy by H3: Value added tax is significantly impact changing the level of taxes through tax on budget deficit of the country. policy changes. Early studies by Hinrisch (1966) and Musgrave (1969) stated the 8. CONCEPTUAL MODEL relationship between the ratios of tax Based on the literature review, revenue to GDP and found that it was following conceptual model was formulated relatively low in the developing countries. to depict the relationship among value added One of the studies that shows on African tax, gross domestic production and budget countries by Leuthold (1991) were stated the deficit of the country. effect of (TAX/GDP) from 1973 to 1981 which used the OLS estimation method. From his study, the share of agriculture will impact the level of taxation and robust the relationship of total tax revenue into direct taxes as well indirect taxes. Ghura (1998) Figure -1: Conceptual model stated the level of taxes will give the different effect to growth and other indicators due to 9. OPERATIONALIZATION the macroeconomic variables such as extent of corruption and adversely affected by the inflation rate in nine African countries from 1985-1996. Ogbonna and Ebimobowei (2012) noted the most comprehensive assessment of the impact tax revenue on economic growth. In his he disaggregated tax revenue into its various components that means varies taxes such as; excise duties, personal income tax, petroleum profit tax, companies' income tax, value added tax and education tax.

05 10. RESEARCH METHODOLOGY c) Sampling Frame Work This study aims to analyze the impact of The secondary data used for the value added tax on gross domestic purpose of collecting the main data for the production and budget deficit of Sri Lanka study from the Central Bank of Sri Lanka. and find out the relationship among value The study was considered whole of the Sri added tax, gross domestic production and Lanka not only for one specific area. budget deficit of the Sri Lanka. Researcher Through the judgmental sampling the ensures that here the data be true and fair researcher considered the period from 2004 because all data was extracted from central to 2013 which covers 10 years in the study bank reports and publication & official with very recent period. website of Inland Revenue - Sri Lanka which are the ultimate organizations of the country d) Reliability and Validity of the Data and also which are come under high The secondary data used in this data, all authority of the country. the relevant data value added tax revenue, gross domestic production and budget a) Data Sources deficit from 2004 to 2013 collected from the Secondary data were used in this study central bank reports, Sri Lanka. The central those secondary data collected from central bank is the highest authority organization in bank reports of Sri Lanka from 2004 to 2013, Sri Lanka to publishing the economical data Publications of Inland Revenue, text book, in Sri Lanka due to that the collected data are journals, magazines and local news papers. reliability and validity data in this study. b) Research Design e) Methods and Measures This study used exploring research In the quantitative approach, various design for collecting, analyzing and statistical methods were employed to evaluating quantitative data in the research compare the collected data from the Central process to understand the research problem Bank Reports. These methods included more completely. In this study the priority of inferential statistics, which involved in the design was given to the quantitative drawing conclusions about a population methods because the quantitative research based only on sample data. It included study can only used to answer the research correlation analysis and single regression questions as “Do value added tax impact on analysis. gross domestic production and budget deficit” and “Is there any relationship among Descriptive Statistics were carried out to value added tax, gross domestic production verify the sample characteristics. In a way, and budget deficit” as well answer to the Mean, and Standard deviation are used to hypothesis of the study. describe the variables.

06 Correlation Analysis was used to find out consider south Asian countries' value added the significant relationship among value tax revenue, gross domestic production, added tax, gross domestic production and budget deficit, their economic policy on budget deficit of Sri Lanka. increasing government's revenue, increasing gross domestic production and other macro Regression Analysis was used to find out economic variables such as unemployment the significant impact of value added tax on rate, inflation rate, per capita income, money gross domestic production and budget deficit supply, economic growth rate and exchange of Sri Lanka. And also the data analysis for rate for the Sri Lankans stability economic the proposed research was performed with growth. Meanwhile, In terms of economic the help of the latest SPSS computer growth rate, 5 percentage growth level has package. been achieved by the Sri Lankan economy last recent ten years approximately. 11. RESULTS AND INTERPRETATION b) Correlation Analysis a) Descriptive Analysis

Based on the Descriptive analysis, the Sri Lankan economy had 191,241.4 million LKR value added tax revenue, 4,863,014 million LKR gross domestic Table 3 shows the correlation analysis, production and 346,919.7 million according to the correlation analysis it can be approximately for recent ten years. Due to seen that value added tax revenue that, we have to think that whether these significantly correlated with gross domestic achievements are in the effective or not, production and budget deficit of the country

According to the economic perspective. Sri (P < 0.01). Hence the H1 is accepted. Lanka is one of the developing countries in south Asian region so Sri Lanka has to

07 c) Regression Analysis revenue) on the dependent variable (gross domestic production) and other remaining part did not explain in this study. Above table 5 ANOVA table in the regression analysis which is significant here P value is 0.000. It is below than the level 0.01 or 1%. Therefore, we can conclude that 1% of the impact is in the significant level. From the table 6 coefficients in the regression analysis, beta value between value added tax revenue and gross domestic production of Sri Lanka is 0.930 which is significant at 0.01 levels (P < 0.01). Finally, In terms of the Regression analysis, we can come to the conclusion that value added tax revenue is significantly impact on gross domestic

production of Sri Lanka. Hence the H2 is accepted.

According to the table 4, Model Summary adjusted R square (R2) is 0.849. It means that there is 84.9% impact of the independent variable (value added tax

08 Table 9: Coefficients Sri Lanka and which are in the significant level. And also, there is significant relationship among value added tax revenue, gross domestic production and budget deficit in the Sri Lanka. Currently budget deficit, instability of the political situation, instability of the price, instability of the nature, economic crisis, unemployment and low gross domestic production are the major issues in many countries. Also Sri Lanka is facing the budget deficit continuously due to that it is one of the major economical problem in the country. Budget deficit of the According to the table 7, Model country mainly depends on two major things 2 Summary adjusted R square (R ) is 0.668. It such as total government revenue and total means that there is 66.8% impact of the government expenses of the country. Here independent variable (value added tax any government cannot avoid its basic revenue) on the dependent variable (budget expenditure of the country it may be capital deficit). Above table 8 ANOVA test in the expenditure and current expenditure even regression analysis which is significant here though some capital expenditures much be P value is 0.002. It is below than the level needed for the future development of the 0.01 or 1%. Therefore, we can conclude that country as well some current expenditure 1% of the impact is in the significant level. much be needed for the current survival of From the table 9 coefficients in the the country so the government has to find out regression analysis, Beta value between tax the unnecessary capital and current policy changes and tax revenue of Sri Lanka expenditure and take action if it is avoidable, is 0.704 which is significant at 0.01 levels (P this is one way to reduce budget deficit of the < 0.01). Finally, In terms of the Regression country. analysis, we can come to the conclusion that value added tax revenue significantly impact The government also can focus to on budget deficit of Sri Lanka. Therefore the increase the total revenue of the country to

H3 is accepted. reduce the budget deficit or avoid the budget deficit. There two pars under the government 12. CONCLUSION AND revenue such as tax revenue and non-tax RECOMMENDATIONAS revenue here tax revenue plays a major role Based on the study value added tax in the total government revenue especially revenue significantly impact on gross indirect tax revenue contribute very high domestic production and budget deficit of level to the total tax revenue. Under the

09 indirect tax revenue value added tax revenue domestic production and budget deficit from is the major one in Sri Lanka. Value added economic indicators of Sri Lanka from 2004 tax is tax on domestic consumption of goods to 2012. and services. Here high level of the value added tax charging may reduce the gross Therefore further researcher can take domestic production of the country. Low the period from the introduction of the value domestic production will lead to the low added taxation in Sri Lanka up to the current level of value added tax revenue. According period for the analysis which study can bring to the results of the study value added tax the ultimate findings on the topic of the revenue is significantly impact on gross research as well as researcher may consider domestic production and the budget deficit other economic indicators of the country for of the country. So according to this finding the development of the country. the makers can make effective fiscal policy to increase the tax revenue and As much interest researcher in the field budget deficit of the country. Nation building of taxation and economy of the country, there tax (NBT) and economic service charge are very few research studies in the field of (ESC) are practicing like same as value taxation in Sri Lanka which related study added tax so the government fiscal policy much needed for the country especially for makers have to think about these kind of developing country due to that the further number of tax practice in Sri Lanka because researcher can do their study in the field of this practices are creating problems under taxation to contribute to the country. the charging of value added tax, nation The future researches they may building tax and economic service charge. consider the same research topic with similar From this study one can be clearly seen that country as comparative study. through the effective policy of value added tax, the government can make changes in the The future researches can do the gross domestic production as well budget research in the same heading in other deficit of the country. Furthermore the countries to enhance the knowledge in the government should consider the effective field. functions of the Inland Revenue and try to establish its branches in the every district and REFERENCES take actions to fulfill the available vacancies Agbeyegbe, Terence, Stotsky J. G. & Wolde in the Department of Inland Revenue to M. A. (2004). liberalization, increase the tax revenue of the country. exchange rate changes and tax revenue in sub-Saharan Africa‖. IMF Working Paper WP/04/178 Washington D.C.: 13. FUTURE RESEARCHES International Monetary Fund. Central This research has focused only value Bank of Sri Lanka. Annual Report. Sri added tax from tax revenue and gross

10 Lanka: Central Bank of Sri Lanka. development‖. Harvard Law School (2013). I n t e r n a t i o n a l Ta x P r o g r a m Dessai, M.A., Foley, C.F. & Hines, J.R. Development. (2004). Foreign Direct Investment in a Lim, D. (1983). Instability of Government World of Multiple Tax‖. Journal of Revenue and Expenditure in Less Public Economics, 88, (pp 2727- Developed Countries‖. World 2744). Development, 11(5), (pp 447-450). Economic and Social Statistics of Sri Lanka: Lymer, A. & Oats, L. (2009). Taxation: Central Bank of Sri Lanka. 2014. Policy and Practice, 16 t h ed. Eriksen, K. & Fallan, L. (1996). Tax Birmingham: Fiscal Publications. knowledge and attitudes towards Mahdavi S. (2008). The level and taxation: A report on a quasi composition of tax revenue in experiment‖. Journal of Economic developing countries: Evidence from Psychology, 17, (pp 387402). unbalanced panel data‖. International Glomm,G., & Ravikumar B. (1998). Taxes Review of Economics and Finance 17, government spending on education and (pp 607617). growth‖. Review of Economic Marsden, K. (1983). Links between taxes Dynamics 1, (pp 306325). and economic growth‖. World Bank Gober J.R. & Burns J.O. (1997). The Staff Working Paper Number 605, the Relationship between Tax Structures World Bank, Washington. and Economic Indicators‖. Journal of McKerchar, M. (2007). Tax complexity and International Accounting, Auditing & its impact on tax compliance and tax Taxation, 6, (pp l-24). administration in Australia‖ 2007 IRS Hinrisch H.H. (1966). A general theory of tax Research Conference, June 13 and 14, structure change during economic Georgetown University Law Center.

11 Proceeding of International Conference on Contemporary Management - 2015 (ICCM-2015), pp 12-23

DIVIDEND PAYOUT AND FIRM PERFORMANCE: A STUDY OF LISTED MANUFACTURING COMPANIES IN , SRI LANKA

Revathan, T., Madhuwanthi, W.M.D., Aspara,J., Dharmadasa,M.S.P ., Justin Shanthan, J., Kawitha, V., Nilushan, P.,Priyadarshani,N.R.N.,Pirathap, A., Pankajarani,V., &SapesanS.

ABSTRACT Several theories have been documented on the relevance and irrelevance of dividend policy. The main purpose of this study is to establish the relationship between dividend payout and firm performance among listed manufacturing firms in the Colombo Stock Exchange (CSE). The correlation analysis carried out to find out the relationship of dividend payout and the profitability (r = 0.487) and the results of the regression analysis exposed identity the impact of dividend payout on profitability (R2= 0.237).Consequently their relationship was also moderate and positive. The findings indicated that dividend payout was a crucial factor affecting firm performance. Managers should offer tolerable time in designing a dividend payout that will enhance firm performance.

Keywords: Dividend Payout, Firm Performance, Colombo Stock Exchange. 1. INTRODUCTION potential implications for share prices and The dividend payment is one of the hence returns to investors, the financing of most important decisions in any organization internal growth and the equity base through in order to achieve efficient performance, retentions together with its gearing and and the issue of dividend policy is a very leverage Omran&Pointon, (2004). important one in the current business Frankfurtet&McGoun (2000) concluded environment. that the dividend puzzle, both as a share value-enhancing feature and as a matter of Dividend policy is therefore, consi- policy is one of the most challenging topics dered to be one of the most important of modern financial economics. Mizuno financial decisions that corporate managers (2007) agrees to the fact that a firm ought to encounter (Baker and Powell, 1999). It has pay dividends to shareholders if it cannot

Department of Accounting Faculty of Management Studies & Commerce University of Jaffna, Sri Lanka Email:[email protected] 12 identify suitable investments which would stakeholders. Through dividends investors bring higher returns than those expected by can value a company and for them it is a the shareholders. regular income whether declare today or at some future date. Dividend policy also has Researchers have different views about implications for managers because when whether dividend payout materially affects they distribute dividends they will have the long term share prices. Dhanani, (2005) fewer funds available to invest in projects, who used a survey approach to capture thus their investment decision depends on managerial views and attitudes of corporate dividend policy. For lenders the more a managers regarding dividend policy found company declares dividends the fewer that dividend policy serves to enhance amounts will remain for lenders claim. corporate market value. However, Farsio, Generally the study is planned to find out the Geary & Moser(2004)argues that empirical association between dividend payout and studies that conclude a causal relationship firm performance. exists between earnings and dividends are based on short periods of time and are therefore misleading to potential investors. 2. RESEARCH PROBLEM Therefore, dividends have no explanatory Despite the numerous studies power to predict future earnings. This Arnott&Asness 2003; Farsio et al 2004 and research therefore tries to establish whether a Nissim&Ziv(2001) that have been done, relationship exists between dividend payout dividend policy remains an unresolved issue and firm performance. in corporate finance. Several theories have The signaling theory proposes that been proposed to explain the relevance of dividend policy can be used as a device to dividend policy and whether it affects firm communicate information about a firm's value, but there has not been a universal future prospects to investors. Cash dividend agreement Stulz, 2000; Pandey, 2003; announcements convey valuable information, DeAngelo&DeAngelo (2006). Researchers which shareholders do not have, about Amidu (2007), Lie (2005), Zhou &Ruland management's assessment of a firm's future (2006), Howatt et al. (2009), continue to profitability thus reducing information come up with different findings about the asymmetry. Investors may therefore use this relationship between dividend payout and information in assessing a firm's share price. firm performance. A study by Amidu (2007) Dividend policy under this model is revealed that dividend policy affects firm therefore relevant Al-Kuwari(2009). performance as measured by its profitability. The results showed a positive and significant A company's dividend policy has relationship between return on assets, return implications for many parties such as on equity, growth in sales and dividend managers, investors, lenders and other policy. Howatt et al. (2009) also concluded

13 that positive changes in dividends are 4. RESEARCH OBJECTIVES associated with positive future changes in The general objective of the research earnings per share. In contrast, Lie (2005) was to establish the relationship between argues that there is limited evidence that dividend payout and firm performance dividend paying firms experience among listed companies in Sri Lanka. The subsequent performance improvements. following specific research objective is; A number of studies Arnott&Asness 2003; Farsio Geary, A., & Moser, J. (2004) and 1. To identify the impact of dividend payout Nissim&Ziv(2001) have been done with on firm performance. regard to dividend policy and firm performance, especially in developed 5. REVIEW OF LITERATURE economies. Can the findings of those studies This chapter focuses on previous Aivazian, Booth & Clearly (2003) and Al- studies done by various authors in relation to Haddad, et al., (2011) be replicated in dividend policy and firm performance. The developing countries? In Sri Lanka, few chapter is divided into three sections. The empirical studies have been done to establish first section gives a definition for dividends the relationship between dividend payout and dividend policy. The second section and firm profitability. This study therefore discusses the key theoretical considerations comes in to fill the gap by establishing from previous studies to inform the general whether there is a relationship between and specific objectives developed for this dividend payout and firm profitability study, that is, dividend policy and firm among listed manufacturing companies in performance; extend of their relationship; Sri Lanka. factors that affect dividend policy and forms of dividend policy used by listed firms. The 3. RESEARCH QUESTIONS third section gives a brief description of the The research was guided by the research methodologies used by previous following research questions; studies in attaining their objectives.

1. What relationship exists between 5.1.Theoretical Framework dividend payout and firm performance 5.1.1. Bird-in-the-hand theory a m o n g l i s t e d m a n u f a c t u r i n g The "Bird in Hand" theory of Gordon companies in SriLanka? (1962) argues that outside shareholders 2. What is the extent of the relationship prefer a higher dividend policy. They prefer a between dividend payout and firm dividend today to a highly uncertain capital performance? gain from a questionable future investment.

14 A number of studies demonstrate that this suboptimal investment (Arnott&Asness, mode fails if it is posited in a complete and 2003).This is based on the assumption that perfect market with investors who behave suboptimal investments lays the foundation according to notions of rational behavior for poor earnings growth in the future (Miller and Modigliani, 1961; Bhattacharya, whereas discipline and a minimization of 1979). conflicts will enhance growth of future earnings through carefully chosen projects. 5.1.2. Agency theory Therefore, paying dividends to reduce the Even if a firm does not have free cash free cash flows enhances the performance of flow, dividend payments can still be useful a company since managers will have less for the shareholders in order to control the cash flow thus avoiding suboptimal overinvestment problem. Easterbrook investments. This is also consistent with the (1984) argues that dividends reduce the over agency cost theory. investment problem because the payment of dividends increases the frequency with Another explanation by Arnott & which firms have to go to equity markets in Asness (2003) for the positive relationship order to raise additional capital. In the between dividend payout and growth in process of attracting new equity, firms future earnings is that managers are reluctant subject themselves to the monitoring and to cut dividends. A high payout ratio disciplining of these markets. This lowers indicates management's confidence in the agency cost. stability and growth of future earnings and allows payout ratio suggests that 5.2. Empirical studies management is not confident of the stability Arnott &Asness (2003) suggested that of earnings or sustainability of earnings the positive relationship between current growth (Arnott&Asness, 2003). Managers dividend payout and future earnings growth therefore pay low dividends to avoid dividend is based on the free cash flow theory. Low cuts when earnings drop. The positive dividend resulting in low growth may be as a relationship is also driven by sticky dividends result of suboptimal investment and less than combined with mean reversion in more ideal projects by managers'withexcess free volatile earnings (Arnott&Asness, 2003). The cash flows at their disposal. This is temporary increases and decreases in earnings prominent for firms with limited growth subsequently reversed cause the payout ratio opportunities or a tendency towards over- to be positively correlated with future investment. Paying substantial dividends earnings growth. Their robustness check for which in turn would require managers to the mean reversion of earnings suggested raise funds from issuance of shares, may that earnings seem to revert to the mean but subject management to more scrutiny, may revert most strongly in terms of their reduce conflicts of interest and thus curtail ratio to dividends.

15 Velnampy (2006) examined the Commercial bank Ltd in Sri Lanka over the financial position of the companies and the period of 10 years from 1997 to 2006. They relationship between financial position and found that, sales are positively associated profitability with the sample of 25 public with profitability ratios except operating quoted companies in Sri Lanka by using the profit, return on equity and number of Altman Original Bankruptcy Forecasting depositors are negatively correlated to the Model. His findings suggest that, out of 25 profitability ratios except operating profit companies only 4 companies are in the and return on equity. Likewise, number of condition of going to bankrupt in the near advances is also negatively correlated to the future. He also found that, earning/total assets return on average shareholders' funds. ratio, market value of total equity/book value of debt ratio and sales/total assets in times are A firm's dividend policy is seen as a the most significant ratios in determining the major determinant for a firms' performance financial position of the quoted companies. Brigham (1995). Similarly, Zakariaand Tan (2007) also stressed the fact that investments Velnampy (2013) in his study of made by firms' influence the future earnings corporate governance and firm performance” and future dividends Potential. with the samples of 28 manufacturing companies using the data representing the Miller & Modigliani (1961) argued that periods of 2007/2011 found that under certain simplifying assumptions, the determinants of corporate governance are dividend decision does not affect the value of not correlated to the performance measures a firm and is, hence, unimportant. Yet, of the organization. Regression model traditional wisdom with changed showed that corporate governance doesn't postulations advocates that a properly affect companies' ROE and ROA. managed dividend policy is vital to shareholders because it can affect share Nissim & Ziv (2001) showed that prices and shareholder's wealth. This dividend increases were directly related to argument is based upon two assumptions future increases in earnings in each of the that there is no tax disadvantage to an two years after the dividend change investor to receiving dividends, and the Likewise, Zeckhauser& Pound (1990) in a second is that firms can raise funds in capital related study found out that there is no markets for new investments without significant difference among dividend bearing significant issuance costs. The payouts with or without large block proponents of the second school feel that shareholders. dividends are bad for the average Velnampy and Nimalathasan (2009) stockholder because of the tax disadvantage investigated the association between they create, which results in lower value. organizational growth and profitability of Finally, there are those in a third group who

16 argued that dividends are clearly good dividend policy affects firm performance as because stockholders like them. measured by its profitability. The results showed a positive and significant Thus, despite voluminous research on relationship between return on assets, return dividends, corporate managers and financial on equity, growth in sales and dividend economists still face what Black (1976) once policy. described as a dividend enigma with pieces that just don't seem to fit. Zeckhauser& Pound (1990) revealed that found out that there is no significant Mehdi, Hassan and Abouzar ( ) pointed difference among dividend payouts with or the impact of corporate governance on without large block shareholders. In dividend policy within the context of Iran. A addition, Kouki & Guizani (2009), and sample of 85 firms has been selected from all Kumar (2006) also observed in their study Iranian firms listed on the Tehran Stock that managerial ownership appears to have a Exchange during is significant and positive visible and significant effect on dividend but the relationship between ownership payout. concentration and dividend payout did not find. Oskar, Ivan, Oleksandr, Diw (2007) Investigated that two perspectives. First, Samuel KwakuAgyei, Edward Marfo- explore the determinants of the dividend Yiadom (2011) examined the relationship policy in Poland. Second, test whether between dividend policy and performance of corporate governance practices determine banks in Ghana. The study used panel data the dividend policy in the non- financial constructed from the financial statements of companies listed on Warsaw Stock 16 commercial banks in Ghana for a period Exchange. The findings are based on the of 5 years, from 1999-2003. These financial period 1998-2004. Quantitative measures statements were obtained from the Banking on the quality of the corporate governance Supervision department of Bank of Ghana. for 110 non-financial listed companies. STATA was used for the data analysis. These results suggest that dividends may Indicate that banks pay dividend increase signal the severity of conflicts between their performance. Generally, the result is controlling owners and minority shareholders. shown that dividend policy has an effect on Those dividends in Poland have less of a firm value. signaling role than in the developed capital markets. A study by Amidu (2007) revealed that

17 6. METHODOLOGY Figure-1 : Conceptual frame work The present study used secondary data 5. HYPOTHESES OF THE for the analysis. The data utilized in this STUDY study is extracted from the comprehensive The following hypotheses where taken income statements, cash flow statement and for the study financial position of the sample listed manufacturing companies in Colombo Stock H1: There is significant relationship between the dividend payout and firm Exchange (CSE) database. performance. 6.1. Sampling Design H1a: There is significant relationship between the dividend payout and Sampling design is a definite plan for return on assets. obtaining a sample from a given population. The sample of this study is consists of 12 H1b: There is significant relationship listed manufacturing companies in Colombo between the dividend payout and net Stock Exchange (CSE). profit. H : There is a significant impact of 2 6.2. Mode of Analysis dividend payout on firm performance. In the present study, we analyses our H : There is a significant impact of 2a data by employing correlation; multiple dividend payout on return on assets. regressions& descriptive statistics. For the H : There is a significant impact of 2b study, entire analysis is done by personal dividend payout on net profit. computer. A well-known statistical package like 'Statistical Package for Social Sciences'

18 (SPSS) 16.0 Version and Microsoft excel NPT= 0 + 1DIVP +e ------(2) 2010 was used in order to analyze the data. The following liquidity and profitability Where, ratios are taken into accounts which are ROA Return on Assets given below. DIVP Dividend Payout NPT Net Profit Table 6.1:Calculations of Dependent and Regression Co-efficient Independent variables Error Margin

7. RESULTS & ANALYSIS 7.1. Correlation, Regression and Reliability Analysis

Table 7.1. Correlation, Regression and Reliability Value

Multiple regression analysis was performed to investigate the impact of dividend payout on firm performance. Which the model used for the study is given below.

ROA= f (DIVP) NPT = f (DIVP)

It is important to note that the Return on Assets (ROA)depends upon Dividend Payout (DIVP) and Net Profit (NPT) depends upon Dividend Payout (DIVP). The following model is formulated to measure the impact of dividend payout on Profitability.

ROA=0 + 1DIVP +e ------(1)

19 The above mentioned table indicates % are not explained, because the remaining the relationship between the independent and part of the variance in firm performance is various dependent variables used in the related to other variables which are not study. As it is observed in the table, the depicted in the model. correlation values were found to be positive between the variables. Return on assets and An examination of the model summary net profit have 48.7% and 39.4% relation in conjunction with ANOVA (Fvalue) (moderate positive) with dividend indicates that the model explains the most payoutrespectively. Which are significant at possible combination of predictor variable 1 percent level of significance. that could contribute to the relationship with the dependent variables. Model created by the researcher is significant at 5% level of 8. REGRESSION significance. F value is 18.010 and Table 8.1:Model Summary respective P value is 0.000 which is statistically significant at 5 percent level of significance. In this case it reveals that only DIVP has a significant impact on ROA at 5 percent level of significance. However, it should be noted here that there may be some other variables which can have an impact on firm performance, which need to be studied. In addition to the above analysis Durbin- Regression analysis is used to test the Watson test also carried out to check the auto impact of dividend payout on firm correlation among the dependent variables. performance of the listed manufacturing companies in CSE. As we mentioned in mode Table 8.2:Model Summary of analysis, a model was formulated and the results are summarized in the above Table- 10.1.

The specification of the variable ROA in the above model revealed the ability to predict firm performance (R2 = 0.237). In this model R2 value of above mentioned profitability measures denote that 23.7 % to the observed variability it can be explained Regression analysis is used to test the by the differences in independent variability impact of dividend payout on firm namely dividend payout. The remaining 76.3 performance of the listed manufacturing

20 companies in CSE. As we mentioned in mode 9. HYPOTHESES TESTING of analysis, a model was formulated and the results are summarized in the above Table-8.2 Table 9.1: Testing of Hypotheses

The specification of the variable ROA in the above model revealed the ability to predict firm performance (R2 = 0.155). In this model R2 value of above mentioned profitability measures denote that 15.5 % to the observed variability it can be explained by the differences in independent variability namely dividend payout. The remaining 84.5 % are not explained, because the remaining part of the variance in firm performance is related to other variables which are not depicted in the model.

An examination of the model summary in conjunction with ANOVA (Fvalue) indicates that the model explains the most possible combination of predictor variable 10.CONCLUSION that could contribute to the relationship with This study basically looked at dividend the dependent variables. Model created by payout and firm performance in Sri Lanka. the researcher is significant at 5% level of The study came up with findings that are of significance. F value is 10.636 and salient importance to scholars investigating respective P value is 0.002 which is dividend issues in the Sri Lankan context. statistically significant at 5 percent level of Based on the hypotheses, the study observed significance. In this case it reveals that only that dividend payout has a significant impact DIVP has a significant impact on ROA at 5 on the firm performance of listed firms in Sri percent level of significance. However, it Lanka. That is, an increase in the financial should be noted here that there may be some welfare of a firm inclines to positively affect other variables which can have an impact on the dividend payout level of firms. Findings firm performance, which need to be studied. from these hypotheses assure that there is a In addition to the above analysis Durbin- significant positive relationship between Watson test also carried out to check the auto dividend payout and the firm performance. correlation among the independent Also second hypothesis say that dividend variables. payout has significant impact on firm performance of the listed manufacturing

21 firms in the Colombo Stock Exchange International Journal of Humanities (CSE). and Social Science, 5(1). Amidu, M. (2007). How does dividend 11. LIMITATIONS &SCOPE FOR policy affect performance of the FURTHER RESEARCH firm on Ghana stock Exchange. The study suffers from certain Investment Management and limitations which are mentioned below. Financial Innovations, 4(2), 104 1. As the study is purely based on listed 112. manufacturing companies in Sri Lanka. Amidu, M. (2007). How does dividend 2. Furthermore, data representing the period policy affect performance of the of 5 years were used for the study. firm on Ghana stock Exchange Investment Management and An important limitation to this paper is Financial Innovations, 4(2), 104 the period for which the data is sampled. The 112. sample horizon for this study is short Arnott, D. R., &Asness, S. C. (2003). compared to other samples in the literature. Surprise higher dividends are higher To address this limitation, future research earnings growth. Financial Analyst can increase the sample size. Finally, it Journal, 70 87. would be of interest if future research can Baker, H. K., & Powell, G. E. (1999). investigate how profitability and dividend How corporate managers view policy will be affected by changes in tax policy, pattern of past dividends, legal rules, Dividend policy? Quarterly financial leverage, opportunities, growth European Scientific Journal May stage and capital structure. Other factors edition vol. 8, No.9 ISSN: 1857 such as ownership structure, shareholder's 7881 (Print) e - ISSN 1857- 7431 expectations, tax position of shareholders, 214. industry practice growth stage capital Miller, M. H., and Modigliani, F. (1961). structure and access to capital markets can Dividend Policy, Growth, and the also be considered in designing a dividend Valuation of Shares, Journal of policy though they affect dividend to a Business 34, 411-433. Doi: moderate extend. 10.1086/294442, http://dx.doi.org REFERENCES /10.1086/29444. Al-Haddad, W. et al. (2011). The effect of Nissim, D. &Ziv, D. (2001) “Dividend dividend policy stability on the changes and future profitability”, Performance of banking sector. Journal of Finance, vol. 56 (6): 21112133.

22 Nissim, D. &Ziv, D. (2001) “Dividend Velnampy, T., &Nimalathasan, B. changes and future profitability”, (2008). An association between Journal of Finance, vol. 56 (6): organizational growth and 21112133. profitability: A study of commercial Samuel KwakuAgyei, Edward Marfo- bank of Ceylon LTD SriLanka. Yiadom (2011) Dividend Policy and Annals of University of Bucharest, Bank Performance in Ghana, Economic and Administrative International Journal of Economics Series, (2), 46-57. and Finance Vol. 3, No. 4; Zeckhouser R.J. & Pound, J. (1990) “Are September 2011. large shareholders effective monitors? Velnampy, T. (2005). A Study on An investigation of share ownership Investment Appraisal and Profitabi- and corporate performance”, in lity. Journal of Business Studies, 2, 23- Hubbard, R.G. (ed.), Asymmetric 35. information, corporate finance and Velnampy, T. (2013). Corporate investment, Chicago: The University Governance and Firm Performance: of Chicago Press. A Study of Sri Lankan Manufactu - ring Companies. Journal of Economics and Sustainable Development, 4(3), 228-235.

23 Proceeding of International Conference on Contemporary Management - 2015 (ICCM-2015), pp 24-35

IMPACT OF CAPITAL STRUCTURE ON FIRM VALUE: EVIDENCE FROM LISTED MANUFACTURING COMPANIES ON COLOMBO STOCK EXCHANGE (CSE) IN SRILANKA

Mathanika .T, Virginia Vinothini. A.G, & Paviththira.R

ABSTRACT Capital structure is most significant discipline of company's operations. This study is an attempt to investigate the impact of capital structure on a firm's value of listed manufacturing companies on Colombo Stock Exchange (CSE) in Sri Lanka. We used secondary data from 15 manufacturing companies on using Random sampling method. Correlation and multiple regression analysis techniques were used to analyses the impact of capital structure on firm value. Debts to equity ratio have significant influence on firm value but debts to total assets have not significantly associated with firm value. The study finding leads to the conclusion that the equity ratio, and debt ratio have significant impact on Firm Value of the Companies. The researcher proved that these findings are supported the prior empirical findings.

Keywords: Capital Structure, Firm Value, Colombo Stock Exchange (CSE).

1. INTRODUCTION each period accrues to the benefit of its A company applies its assets in its shareholders (in the form of dividend and business to generate a stream of operating retained earnings). If instead the company cash flows. The capital structure of a firm is has borrowed a portion of its capital, it must actually a mix of different securities. In dedicate a portion of the cash flow stream to general, a firm can choose among alternative service this debt. Moreover, debt holders capital structures. After paying taxes, the have the senior claim to a company's cash firm makes distributions to the providers of flow; shareholders are only entitled to the its capital and retains the balance for use in residual. The company's choice of capital its business. If a company has equity capital structure determines the allocation of its the entire after-tax Operating cash flow for operating cash flow each period between

Students Department of Financial Management University of Jaffna, Srilanka. E mail: [email protected], [email protected], [email protected] 24