Testing Pecking Order Theory On Dividend Payout Ratio In Ghana

The Pecking Order Theory (POT) suggests that firms prefer internal over external sources of financing investment. For external sources of finance, firms prefer the use of debt before equity to finance investment. However, the POT did not show how the capital structure decision of firms influences their dividend decision. POT can be combined with Lintner's dividend model to generate some predictions for financial leverage. This leads to the conclusion that when firms are faced with earnings shortage, firms will borrow to pay dividend at the expense of profitable investment. This means there will be a positive interaction between financial leverage and dividend payout ratio, and a negative interaction between financial leverage and investment. The theory further predicts that as firms make more profit, they would demand less debt representing a reduction in financial leverage. The predictions of the POT where made based on data from developing countries. However, due to differences in accounting and auditing practices between developed and developing countries, these predictions might not hold in developing economies. A cross sectional analysis was implemented on 33 out of the 34 listed firms on the GSE for the period 2004-2009, employing both the 3SLS and OLS technique to test the predictions in Ghana. The findings indicate that there is a positive significant interaction between financial leverage and dividend payout ratio among listed firms in Ghana. The results further indicate that profitability has the predicted negative influence on financial leverage, indicating that the POT explains dividend payout ratio in Ghana. The results did not show any significant interrelationship between financial leverage and investment, and between investment and dividend payout ratio among listed Ghanaian firms. The results also show that dividend payout ratio in Ghana is very low, therefore, policymakers should strengthen and enforce laws on dividend payment in Ghana