A consideration of the retention ratio and the impact on selected management and investment performance metrics

Abstract

They would possibly be less contentious if there was conclusive proof that managers were better allocators of capital generated through income retained than investors. Against this backdrop, this study examines the question of whether correlations exist between the amount of income retained by managers to fund capital and various financial management and investment performance metrics. The objective of the study is to test various hypotheses for relationships between the retention ratio and various management and investment performance metrics. The hypotheses includes testing whether dividends are a significant contributor to investor returns, whether there is a correlation between the retention ratio and the share price, between the retention ratio and total investor returns and between the retention ratio and return on equity. A last hypothesis is to test whether there is a correlation between total returns to investors and return on equity. The results of the study did not support any of the hypotheses and the indication is that no firm or clear relationship between the retention ratio and various performance metrics exists for the sample of South African firms over the survey period, namely share price, total investor returns and return on equity. The study could therefore not conclude whether managers were either good or poor allocators of capital generated through income retained. The study could also not determine whether capital retained did impact on future performance measures of a company or not. This outcome of the study was surprising. It was anticipated that there would be either positive correlations supporting managers’ ability to allocate retained income or negative correlations refuting managers’ ability to allocated retained income. This, however, was not evident. The literature reviewed was clear regarding the mystery surrounding dividend distributions and its role within iii corporate finance, but was divided on the drivers of the behaviour. It was hoped that this study would have been able to provide some explanation for dividends in a South African mining industry context. The reasons for the outcome are varied but include the questionable credibility of the data with regards to the size of the sample and the period of study. Therefore, no certain conclusions could be made about managers’ ability to allocate capital generated through retained income and the recommendation is for further research to be conducted with a larger sample over a longer period of study before the results are given undue significance.