Capital structure and dividend policy in a personal tax free environment: the case of Oman

This dissertation examines four specific aspects of capital structure and dividend policy.The first issue concerns the determinants of capital structure dynamics. The primaryobjective is to examine whether stock returns are important factors in firm?s capitalstructure choice, and if so, whether this effect is persistent. In so doing, we use a dataset which (1) avoids the complexity of tax rates faced by previous studies, (2) weintroduce new variables that are unique to Oman, and (3) we distinguish empiricallybetween bank debt and non-bank debt. We find stock returns are a first orderdeterminant of capital structure. Firms do show some tendency to rebalance towardstheir target capital structure. However, the impact of stock returns dominates the effectsof rebalancing. We also find new evidence that firms do take countermeasures to offsetchanges in their leverage that stem from equity value variations, but do so at a lowspeed.The next topic studied concerns the ex-dividend day behaviour. We investigatethis issue using a unique data set where there are no taxes on dividends and capital gainsand stock prices are decimalized. In this economy, any price decline that is smaller thanthe dividends can not be attributed to taxes and price discreteness. We find that thestock price drops by less than the amount of dividends and there is a significant positiveex-day return. We are able to account for our results using market microstructuremodels.The third issue investigated is the stock price reaction to dividendannouncements. Tax-based signaling models argue that dividends would not haveinformation and be informative if it is not for the higher taxes on dividends relative tocapital gains that they apply to shareholders. The absence of personal taxes in Omanpresents a valuable opportunity to test this prediction. Our results show that theannouncements of dividend increases (decreases) are associated with a stock priceincrease (decrease) which contradicts the tax-based signaling models.The final chapter analyzes the determinants and stability of dividend policy offinancial and non-financial firms. Investigating this issue is important for at least tworeasons. First, Omani firms distribute almost 100% of their profits in dividends whichled the Capital Market Authority (CMA) to issue a circular (number 12/2003) arguingthat firms should retain some of their earnings for ?rainy days?. This allows usunderstand the characteristics of firms that pay dividends. Second, firms are highlylevered mainly through bank loans which render the role of dividends in reducing theagency costs less important. Unlike most previous studies, we include both dividendpaying and non-dividend paying firms to avoid a selection bias. We find that there aresome common factors that determine dividend policy of both financial and non-financialfirms and there are some factors that affect only non-financial firms. We also find thatthe factors that influence the probability to pay dividends are the same factors that drivethe amount of dividends paid for both financial and non-financial firms. We documentthat non-financial firms adopt a policy of smoothing dividends while financial firms donot have a stable dividend policy.