Firm Growth and Retained Earnings Behavior – A Study on Indian Firms

Abstract

Growth of corporate firms in India is substantially financed by retained earnings. That there are no transaction and bankruptcy costs associated with retained profits makes retained earnings a major source of finance for companies. Potential growth opportunities would place a greater demand on internally generated funds. The importance attached to corporate income retention in enhancing the growth of firms has been the driving force for the study which analyses potential variables that would affect retained earnings and change in retention behavior among companies differing in their growth levels. The sample size comprises 149 profit making Indian companies across seven different industries. The data collected for the period from 1996-2010 are investigated with the help of correlation and multiple regression.  The results suggest that across the classifications of sample companies cash flow and dividend are found to be the most influencing variables on retained earnings. Companies with low investment opportunities for growth and expansion prefer to distribute much of their earnings as dividend. The potential investment opportunities are likely to arise far off in the future for these companies. So profit, if retained, remains unutilized for long time or utilized in short-term investment opportunities which would yield low return on investment. Such companies prefer to pay out the earnings and raise capital whenever needed. Thus, the level of earnings retained is very much influenced by the growth rate of the companies.

Key words: Retained Earnings, Growth of companies, Cash Flow, Dividend, Net Fixed Assets.