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The impact of dividend policy on price-earnings ratio: The role of conditional and nonlinear relationship

Boonlert Jitmaneeroj (School of Business, University of the Thai Chamber of Commerce, Bangkok, Thailand and Essex Business School, University of Essex, Colchester, UK)

Review of Accounting and Finance

ISSN: 1475-7702

Article publication date: 13 February 2017

3772

Abstract

Purpose

This paper aims to examine the conditional and nonlinear relationship between price-earnings (P/E) ratio and payout ratio. A common finding of previous studies using linear regression model is that the P/E ratio is positively related to the dividend payout ratio. However, none of them investigates the condition under which the positive relationship holds.

Design/methodology/approach

This paper uses the fixed effects model to investigate the conditional and nonlinear relationship between P/E ratio and payout ratio. With the inclusion of fundamental factors and investor sentiment, this model allows for nonlinear relationship to be conditioned on the return on equity and the required rate of return.

Findings

Based on the annual data of industries in the USA over the period of 1998-2014, this paper produces new evidence indicating that when the return on equity is greater (less) than the required rate of return, the P/E ratio and dividend payout ratio exhibit a negative (positive) relationship and positive (negative) convexity.

Practical implications

Due to the curvature relationship between P/E ratio and payout ratio, the corporate managers and stock investors should pay more attention to the reduction in payout ratio than the rising payout ratio and the companies with low payout ratios than the companies with high payout ratios.

Originality/value

No previous study has tackled the issue of conditional and nonlinear relationship between P/E ratio and payout ratio. This paper attempts to fill the gap by allowing for nonlinear relationship conditional on the relative values of the return on equity and the required rate of return.

Keywords

Citation

Jitmaneeroj, B. (2017), "The impact of dividend policy on price-earnings ratio: The role of conditional and nonlinear relationship", Review of Accounting and Finance, Vol. 16 No. 1, pp. 125-140. https://doi.org/10.1108/RAF-06-2015-0092

Publisher

:

Emerald Publishing Limited

Copyright © 2017, Emerald Publishing Limited

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