THE RELATIONSHIP BETWEEN AGENCY COSTS AND DIVIDEND POLICY AMONGST LISTED FIRMS AT NAIROBI SECURITIES EXCHANGE BY STEVEN JOHN CHIROMBO A RESEARCH PROJECT PRESENTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE AWARD OF MASTER OF SCIENCE IN FINANCE, SCHOOL OF BUSINESS, UNIVERSITY OF NAIROBI NOVEMBER 2017 DECLARATION I declare that this research project is my original work and has not been presented for an award of any degree in any other University. Signed: ………………………………….…………………….. Date: ………………………………………………………….. Steven John Chirombo D63/83848/2016 This research project has been submitted for examination with my approval as the candidate’s university supervisors. Signed: ………………………………….…………………….. Date: ………………………………………………………….. Mr. Dan Chirchir Lecturer Department of Finance and Accounting. Signed: ………………………………….…………………….. Date: ………………………………………………………….. Dr. Kennedy Okiro Lecturer Department of Finance and Accounting. i DEDICATION To my wife Ruth and my son Wabwino and daughter Bertha for your support and enduring my absence from home. ii ACKNOWLEDGEMENTS First and foremost my appreciation to the Almighty God for the opportunity availed to me to study and for answering to my prayers. My wife and children for always being there for me with your support and encouragement when situation became thick. To my financiers, scholarship fund of Malawi and my colleagues at office for your encouragement. Finally but not least my supervisors Mr Dan Chirchir and Dr. Kennedy Okiro for the guidance and unceasing support for the completion of this project. iii LIST OF TABLES Table 4.1 : Descriptive Analysis ………………………………………………... 35 Table 4.2a: Normality Test (descriptive) …………………………………….….. 37 Table 4.2b: Normality Test (Shapiro –Wilk) ………………………………….…..38 Table 4.3a: Correlation Analysis …………………………………………………39 Table 4.3b: Multicollinearity Test ………………………………………………..40 Table 4.4 : Autocorrelation (Durbin Watson) Test …………………………...….41 Table 4.5 : Model Summary ……………………………………………………..42 Table 4.6 : Coefficient Results …………………………………………………...43 Table 4.7 : ANOVA Test ...………………………………………………………44 iv LIST OF FIGURES Figure 2.1 Variable direction and description ................................................. 24 Figure 2.2 Conceptual Framework .................................................................. 25 v ABBREVIATIONS AIM Alternative Investment Market AUR Asset Utilization Ratio DPR Dividend Payout Ratio FIMS Fixed Income Market Securities FOM Futures and Options Market GDP Gross Domestic Product IOS Investment Opportunity Set LIQ Liquidity MIM Main Investment Market NSE Nairobi Stock Exchange OER Operating expenses ratio PROFIT Profitability SIZE Firm Size SPSS Statistical Package for Social Sciences vi ABSTRACT The paper investigates the relationship between agency costs and dividend policy in the context of developing economy of Kenya. Dividend policy has been and still remains a tricky topic as the results are not conclusive as to allow a definite position to be made. Thus therefore, the study has used 10 year data from 2007 to 2016 based on a sample of 40 companies. This has seen employment multi linear regression technic to analyze the results which confirms the results of other studies that agency costs do influence dividend policy. The independent variables were positively correlated to the dependent variable, the dividend policy as expected but only asset utilization ratio and profitability had significant influence at P-Value of .011 and .002 respectively. The R2 of 40.2 percent of the model explain the effect of change influenced by the agency cost variables on dividend policy. The P. Value of F-test was significant at 0.003 (0.003 < .05) indicating linear relationship. Therefore, the study concluded that agency costs influences the dividend policy of firms listed on NSE. vii TABLE OF CONTENTS DECLARATION............................................................................................... i DEDICATION.................................................................................................. ii ACKNOWLEDGEMENTS ...........................................................................iii LIST OF TABLES .......................................................................................... iv LIST OF FIGURES ......................................................................................... v ABBREVIATIONS ......................................................................................... vi ABSTRACT .................................................................................................... vii CHAPTER ONE .................................................................................................................. 1 INTRODUCTION................................................................................................................ 1 1.1 Background of the study .............................................................................. 1 1.1.1 Agency Costs ................................................................................... 2 1.1.2 Dividend Policy ............................................................................... 4 1.1.3 Relationship between Agency Cost and Dividend Policy ............... 6 1.1.4 Nairobi Securities Exchange ........................................................... 8 1.2 Research Problem ........................................................................................ 9 1.3 Study Objective .......................................................................................... 10 1.4 Value of the Study ..................................................................................... 10 CHAPTER TWO ............................................................................................................... 12 LITERATURE REVIEW ................................................................................................. 12 2.1 Introduction ................................................................................................ 12 2.2 Theoretical Framework .............................................................................. 12 2.2.1 The agency theory of dividend policy ........................................... 13 2.2.2 Agency Cost of Free Cash Flow Theory ....................................... 14 2.2.3 Signaling Theory ........................................................................... 16 2.3 Determinants of Dividend Policy............................................................... 17 2.3.1 Taxation Policy ............................................................................. 17 2.3.2 Liquidity position .......................................................................... 18 2.3.3 Firm size ........................................................................................ 18 2.3.4 Ownership structure ...................................................................... 19 2.3.5 Legal and regulatory constraints ................................................... 19 2.3.6 Restrictions in Debt Contracts ....................................................... 20 viii 2.4 Empirical Evidence .................................................................................... 20 2.6 Conceptual Framework .............................................................................. 25 2.7 Summary of Literature Review .................................................................. 26 CHAPTER THREE ........................................................................................................... 28 RESEARCH METHODOLOGY ..................................................................................... 28 3.1 Introduction ................................................................................................ 28 3.2 Research Design......................................................................................... 28 3.3 Population .................................................................................................. 28 3.4 Sample........................................................................................................ 29 3.5 Data Collection .......................................................................................... 29 3.5.1 Measurement of variables ............................................................. 29 3.5.2 Dividend Payout Ratio .................................................................. 30 3.5.3 Operating expenses ratio ............................................................... 30 3.5.4 Asset utilization ratio .................................................................... 30 3.5.5 Liquidity ........................................................................................ 31 3.5.6 Firm size ........................................................................................ 31 3.5.7 Profitability .................................................................................... 31 3.6 Diagnostic Tests ......................................................................................... 32 3.7 Data Analysis Techniques .......................................................................... 33 3.8 Summary .................................................................................................... 34 CHAPTER FOUR .............................................................................................................. 35 DATA ANALYSIS AND FINDINGS ............................................................................... 35 4.1 Introduction