THE PAYOUT POLICY IN THE GCC: THE CASE OF ISLAMIC BANKS

Abstract

The purpose of this research is to define the payout policy of Islamic banks in the GCC and to identify the factors that influence payout distributions. For this purpose, a two stage research strategy was employed. In the first stage, investors’ and managers’ surveys were conducted to measure the perceptions towards payout policies. In the second stage, the survey results are utilized to formulate and test a payout model by multivariate regression analysis.

In the investors’ survey, an electronic questionnaire was posted on internet investment forums in the GCC and sent via email to investors. 287 useable responses were collected. The data was analyzed and the results show that investors prefer to receive dividends due to transaction and agency costs, which supports the dividend relevance hypothesis. The findings suggest that the agency cost is explained by the uncertainty resolution, window dressing and free cash flow hypothesis. Investors were found to assess the payouts, which comprises of dividends and profit distributions for profit and loss saving and investment accounts (PSIA), by comparing it to market and historical rates.

Investors were found to diversify their investments based on risk and return. If the characteristics of an asset (e.g. dividend policy) are changed, investors would switch to other assets that meet their investment objectives. In terms of stock repurchases, investors perceive it as a signal that the stock price is undervalued. On the other hand, stock dividends were interpreted by investors as a stock split or capital increase. As for Islamic banking, customers reported that the primary motivation to deal with these banks is the religious obligation.

In the managers’ survey, semi-structured interviews were conducted with 10 managers to understand the payout process and the factors that influence distributions. The results show that PSIA distributions are mainly driven by competitors’ payouts, historical distributions, and signalling. As for dividends, managers reported that the payout decision is relevant to the firm’s value. Dividends were believed to comply with the increasing stream hypothesis and the Lintner model. Managers believe that stability of the payout policy is perceived by investors as a positive signal of the bank’s strength. They also believe in the maturity and growth effects arguing that new banks have relatively higher capital expenditures which flatten out over time. Consequently, mature banks tend to have higher and more stable dividend distributions. Finally, managers reported that banks’ liquidity and financial ability has a positive relationship with dividend distributions.

Based on the feedback of stage one, a payout model that comprises of PSIA and dividend models was formulated and tested by employing multivariate regression analysis. The study uses the financial data of 13 Islamic banks in the GCC between 1993 and 2008. The results show that PSIA is influenced by competitors’ distribution and historical distribution rates. On the other hand, the results of the dividend model show that dividends are influenced by profitability, historical dividends and the level of maturity. The results of the PSIA model support the competitive payout hypothesis, increasing stream hypothesis, the Lintner model and information signaling hypothesis. The results of the dividend model support the increasing stream hypothesis, the Lintner model, information signaling hypothesis, and the growth and maturity effects. The findings for the competitive payout hypothesis reported by investors, managers, and the PSIA model support the existence of displaced commercial risk, which calls for additional research in this area by the banks and regulators to control it by focusing on research for cooperative insurance schemes, prudent reserve practices, and liquidity management.