Modigliani and Miller (1961) dividend-irrelevance theory says that investors can affect their return on a stock regardless of the stock’s dividend. Investor could then buy more stock with the dividend that is over the investor’s expectations. As such, the dividend is irrelevant to investors, meaning investors care little about a company’s dividend policy since they can simulate their own. Their theory was built on a range of key assumptions, similar to those on which they based their theory of capital structure irrelevancy. Modigliani and Miller (1961) argue that the value of the firm in a perfect capital market depends only on the income produced by its assets not on how this income is split between dividends and the retained earnings. Assumed that in a perfect Capital markets, that is there are no taxes both corporate and personal taxes, no transaction costs on securities, investors are rational, information is symmetrical hence all investors have access to the same information and share the same expectations about the firm’s future as its managers. According to M&M’s irrelevancy theory, if therefore does not matter how a firm divides its earnings between dividend payments to shareholders and internal retentions. Dividend irrelevancy theory asserts that a firm’s dividend policy has no effect on its market value or its cost of capital.
2.1.4 Bird in Hand Theory
Gordon and Lintner (1959), the bird-in-the-hand theory states that dividends are relevant. The bird-in-the-hand may sound familiar as it is taken from an old saying, “a bird in the hand is worth two in the bush.” In this theory “the bird in the hand’ is referring to dividends and “the bush” is referring to capital gains. They argued that investors value dividends more than capital gains when making decisions related to stocks. As a company increases its payout ratio, investors become concerned that the company’s future capital gains will dissipate since the retained earnings that the company reinvests into the business will be less. The essence of the bird-in-the-hand theory of dividend policy is that shareholders are risk-averse and prefer to receive dividend payments rather than future capital gains. Shareholders consider dividend payments to be more certain that future capital gains thus a “bird in the hand is worth more than two in the bush”. Gordon contended that the payment of current dividends “resolves investor uncertainty”. Investors have a preference for a certain level of income now rather that the prospect of a higher, but less certain, income at some time in the future. Investors’ value a dollar expected dividend more highly than a dollar expected capital gain because the dividend yields component is less risky than the expected return hence, believed that investors require and prefer high dividends to capital gains resulting to a generous dividend policy by a firm.
2.1.5 Tax Preference Theory
Taxes are important considerations for investors this is because capital gains are taxed at a lower rate than dividends. The theory states that the reason why investors prefer low dividend payout to high payout: long term capital gained are less taxed as compared to dividend and that taxes on capital gains are not paid unless the stock is sold. According to Miller and Modigliani (1961) and Gordon and Shapiro (1956) in most countries, taxes on dividends are higher than those on capital gains hence investor prefer capital gains to dividends. Capital gains are not paid until an investment is actually sold hence investors can control when capital gains are realized but they can’t control dividend payments which the company has control.
2.1.6 Clientele Effect
The tax preference between dividends and capital gains lead to different clienteles (Miller and Scholes, 1978). Certain investor prefers higher dividends than others who prefer lower this is what is called the clientele effect. Hence if corporations are aware of the demands of their investors for higher dividends yields and for other lower dividend yields then they will be able to adjust their dividend polices to meet the demands. There is a tendency of a firm to attract a set of investor who likes its dividend policy. Black and Scholes (1974), assume that if companies were paying dividends, investors must derive some benefits from the dividends this offset the negative consequences.
2.1.7 Signaling Hypothesis
Dividends are information signals about the performance of a company which investors use to make decisions. According to Gordon (1956), the smoothening hypothesis of dividends by management which predicts that dividends are maintained at a constant arte and any increase are carried out rather cautiously by the firm to avoid significant dividend cuts when the corporate earnings falls. Ross (1977) states that not all investors are the same they regard dividend changes as a signal of management earnings forecasting. It has been observed that the price of a firms stock generally rises when its dividend is increased and the price will fall when the dividend is cut. Thus, firms are expected to raise dividends when the future earnings are expected to rise. This is because managers have better information on of the firm’s performance than the investors. Therefore dividends act as a signal to investors on the current and future performance of the firm. Generally a rise in dividend payment is viewed as a positive signal, conveying positive information about a firm’s future earnings prospects resulting in an increase in share price. Conversely a reduction in dividend payment is viewed as negative signal about future earnings prospects, resulting in a decrease in share price.
2.2 Empirical Review of Related Literature
Kalyanaraman and Al-Tuwajri (2014) investigated the existence of long run relationship among five macroeconomic variables of CPI, industrial output, money supply, exchange rate, oil price along with proxy of S&P 500 and the TASI (Saudi All stock index). They found an existence of long run relationship among the five variables and all the five variables put an impact on stock price whereas S&P 500 index does not impact Saudi stock prices. Vector error correlation model shows the presence of long run causality from the explanatory variables to the stock prices..
Chen, Roll and Ross (1986) studied selected macroeconomic variables in relation to the US stock market returns using the APT model (multifactor model). That is, they studied the impact of macroeconomic forces on stock returns using APT. They examined seven macroeconomic variables, such as: term structure, industrial production, risk premium, inflation, market return, consumption and, oil prices. They revealed a strong relationship between the macroeconomic variables and the expected stock returns during the study period. They observed that industrial production, changes in risk premium, twists in the yield curve, measure of unanticipated inflation of changes in expected inflation during periods when these variables are highly volatile, are found significantly explaining expected stock returns (Burmeister and Wall, 1986, Clare and Thomas, 1994).
Basse and Reddemann (2011) examined inflation and dividend policy of US Firms and pointed that maybe the neglecting of macroeconomic variables as the important reason why empirical tests often fail to support theories of dividend determination. He stable long run relationship between dividend payments and real economic activity and price level.
Abedallat and Shabib (2012)examined the impact of macroeconomic indicators such as change in investment and gross domestic product (GDP) as the independent variables and the movement of Amman Stock Exchange index as dependent variable for the data period of 1990- 2009. For the analysis of the above relationship they used the multiple regressions. They found a relationship between the two macroeconomic indicators (the investment and GDP) and the Amman Stock Exchange index, and also between each of them separately and the stock index, which means that the movement of prices in the Amman Stock Exchange affected by the movement of these two variables, and there is the effect of both variables on the movement of Amman Stock Exchange index.
Arouri and Rault (2010) studied the relationship between oil prices and stock market and tried to explore what drives what in the gulf corporation council (GCC) countries. They applied the recent bootstrap panel cointegration techniques and seemingly unrelated regression (SUR) methods to investigate the existence of a long-run relationship between oil prices and Gulf Corporation Countries (GCC) stock markets, and their investigation showed that there is evidence for cointegration of oil prices and stock markets in GCC countries, while the SUR results indicate that oil price increases have a positive impact on stock prices in all GCC countries except in Saudi Arabia.
Acikalin, Aktas and Unal (2008) investgated that the relationship between stocks return in the Istanbul Stock Exchange (ISE) and the macro economic variables of the Turkish economy. They took the quarterly data sets and applied the cointegration tests and vector error correlation method (VECM), and found that long term stable relationship between ISE and four macroeconomic variables such as GDP, exchange rate, interest rate, and current account balance by applying the causality tests, they found unidirectional relationships between macro indicators and ISE index..
Gazi and Hisham (2010) examined the relationship between macroeconomic variables and stock market returns in the Jordan Stock Market, using cointegration analysis, and affirmed that trade surplus, foreign exchange reserves, money supply and oil prices are important macroeconomic variables that have long run effects on the Jordanian stock market returns. Also, that a negative relationship exists between crude oil price and stock market returns.
Kyereboah and Agyire (2008) investigated how macroeconomic indicators affect the performance of Ghana stock market using quarterly time series data. They observed that lending rates from deposit money banks have an adverse effect on stock market performance and particularly serve as major hindrance to business growth in Ghana. Inflation rate was found to have a negative effect on stock market performance.
In Nigeria, Asaolu and Ogunmuyiwa (2011) examined the impact of long-run and short-run macroeconomic variables on stock prices, using cointegration and error correction model. Their result shows that a long run relationship exists between Average Share Price (ASP) and the macroeconomic variables; however the Granger causality results failed to confirm any relationship between ASP and macroeconomic variables in Nigeria (Gan et al, 2006).
Soyode (1993) examined the relationship between stock prices and macroeconomic variables such as exchange rate, inflation and interest rate in Nigeria. He discovered that the macro economic variables are cointegrated with stock prices and consequently related to stock returns.
Odior(2013) studied the impact of macroeconomic factors on manufacturing productivity in Nigeria using the augmented dickey fuller (ADF) cointegrating equation of the VECM reveals the presence of a long-run equilibrium relationship. Loans and advances and foreign direct investment have positive and significant impact on the level of manufacturing productivity in Nigeria, while broad money supply has less impact.
Olugbenga (2011) examine the impact of macroeconomic indicators such as money supply, interest rate, exchange rate, inflation rate, oil price and gross domestic product on stock prices in Nigeria using the pooled or panel model. The result reveals that macroeconomic variables have varying significant impact on stock prices of individual firms in Nigeria.
Osa and Ikaibo (2002) studied the relationship between macroeconomic variables and stock market index in Nigeria using interest rate, inflation rate, exchange rate, fiscal deficit GDP and money supply .The study showed that macroeconomic variables influence stock market index in Nigeria.
Amadi, Onyema and Odubo (2000) estimated the relationship between money supply, inflation, interest rate, exchange rate and stock prices using multiple regressions in Nigeria. Their results revealed a relationship between stock prices and the macroeconomic variables and are in line with theoretical assumption and empirical findings of other scholars, they further observed that the relationship between stock prices and inflation does not conform to