Perfect Capital Markets, Dividend Policy, and the Capital Investment Risk Factors - Term Paper Example

DIVIDEND POLICY Real e business is a hugely profit making business. It is one of the booming businesses that have given fruitful results to those who invested to gain profits. A real estate business can give good results if the infrastructure of concerned city, town or village is good. Basic facilities like water, electricity, food and shelter should be sufficient. Real estates prices will increase when the land is in the center of the city, or in industrial areas, or in residential areas. Infrastructure of the city or town plays an important role because those are the basic amenities that an investor would look into, before buying the land. Lack of infrastructure and basic facilities would lead to downfall in prices of the land and investors will lose faith and retract the investment. This would be huge disaster for any businessman. One of the problems with real estate investment trusts (REIT) is that the investors tend to over invest and still REIT's must distribute most (about 95%)of the taxable income to the shareholders. Therefore before putting a land to sale check the basic amenities and infrastructure and the price of the land accordingly. UK has become a hotspot for real estate business domestically and internationally. The main reason for this is the presence of strong infrastructure and basic facilities like water and electricity. One of the important factors that have increased the real estate corporate is the high rate of ownership. Real estate has become an alternate investment in UK. It is not sure that how dividend policy affects the value of a firm and the debate still goes on. Some say shareholders wealth is increased by dividends, others believe that dividends don't affect firm's value in other words they are irrelevant and some more believe that shareholders wealth is decreased by dividends. A general definition of valuation of property is to state the actual value of the property both according to the government and private (commercial) sector. But government will valuate only landed property and fertile land. While valuating a property government will not consider the commercial demand that property is possessed with. Financial policy decisions include dividend decisions and according to a financial management research investment is considered as an exogenous variable. Influence of stakeholders has a greater affect on firm's dividend policy that can be observed by examining dividend and investment policy's interactions. Not only the stakeholders but also non-investor stakeholders and capital suppliers plays a greater role in affecting the firm's dividend policy. Some financial theorists were able to provide a hypothesis foe dividend policy irrelevance. The assumptions of this theory are Perfect capital markets, in other words non existence of taxes transaction costs, a single buyer or a seller cannot influence the market price which in other words termed as non existence of monopoly in the market and information should be accessed without any cost that is free of cost. There should be reasonable behaviour on the part of those who are taking part in the market. The future cash flows on the discounted value that are accruing to investors should have valuing securities. Certainty of the firm and investment policy and as well as having complete knowledge of future cash flows on the discounted value are considered important in this theory. Managers are considered as agents of the stakeholders. One assumption that not hold good is about the certainty of the investment policy of the firm which is critically viewed. A model was developed by Titman that hypothesises an interaction between investment and financial decisions. According to this model non-investor stakeholders wealth in a firm can be maximised by those equity holders who possess incentives. A company or a manufacturing unit intending to set up its own plant in any country has to look up, analyze and study the respective location then plan to take up the initiative. It has to take into consideration - all the aspects related to starting a unit, develop it and to see it turn into a successful, lucrative unit, in its own terms. When the matter concerns to a car-manufacturing unit there arise two kinds of firms vying for the plant to set up. If the firm has been liquidated then these stakeholders are the major losers who suffer heavy losses and the costs may be in the form of job search costs, rise in maintenance costs for customers or retooling. There is also an uncertainty that prevails and the firm has to bear the costs of it. If the firm has been closed or goes out of business then it is the customers who have to bear the liquidations costs and they believe that the money that they are paying for the goods and services will be discounted to reflect these anticipated costs. Domestic firms have good foothold on local area, climatic conditions, contact ability, without any language barriers, they have access at a much more faster rate than expected. Even then domestic firms also have a sort of impulsive effect on a few problems with regards to setting up of the unit as well as benefits. Foreign company to invest in any other country and set up a plant would land with dreams to establish a kingdom of their own. At times they are successful, at times they are partly successful, and at times they fizzle out. But more often then not they make their dreams true to the expectations. Their product will be precision based and also quality based. Within a short period even though they get hurdles and hardships at the beginning they overcome all the difficult toothaches and launch the product successfully. Another model is signalling model that has the following points: Insiders possess incentives that are used to manipulate dividend announcement that effects for short-term gain. The incentive that the insiders possess to have short-term gain is the declaration of unwarranted dividends, thus affecting the stock price and making it to temporarily rise. The firm insiders can increase firm's net dividend by cutting investment. There is a high possibility that outside investors may expect such false signals and discount them appropriately. If they fail to recognise this signal then it is viewed as a bad news. Thus the failure of recognising the driving signal will result in second best dividend and investment policy. The well-documented evidence of dividend announcements will have clear impact on informational asymmetries between the decision makers and investors. The important missing information about the firm's earnings can be known with the help of net dividend announcements. Insiders can prevent stock-price dilution by firms raising a new equity by taxable dividend signaling. It is the duty of the firm to raise capital by issuing shares if the investment is held constant. If the above step is taken a problem arises where the current stock price becomes undervalued and thus selling shares results in the dilution of current shareholder's wealth. The firms optimise dividend levels by balancing cost of additional taxes versus reducing dilution. The shareholders pay income tax on dividends. It is possible that outsiders may be perfectly able to audit firm's current cash flow and earnings but have no idea or not perfectly informed about the value of the future projects. The capital investment is involved with a lot of risk factors as of to how to invest and where to invest. As setting up of a car manufacturing and sales unit holds large amount of money, considering rate of interest, mode of payment, forms of receipt, and confirmation reports satisfying the Audit bureau of the existing country is great challenge if one could accept. Also the company has to pay a certain percentage of amounts as stake over the profit, which is only applicable to multi-national firms. Lets look at some of the points on agency cost: Mostly concentrated on agency-cost explanation of dividends. One reason of the existence of dividends is that they influence firm's financial policies. Dividends tend to dissipate cash and induce firms so that new securities can be floated. Managers constantly raise capital and attenuate agency costs as well as managerial risk aversion. This step of raising capital comes under scrutiny of investment bankers and the intermediaries of capital market. It is also viewed that new investors are much sought after than the old ones and better in chiseling down the agency costs. Though other devices can be used to perform the same agency reducing role, dividends are considered above them because of their low cost means of reducing agency costs. Stock Repurchases It is the managers who signal firm value by share repurchases and dividends. The cost structure developed through signalling model favours share repurchases. Firms that have large under-valuations do signalling of share repurchasing and thus provoke large share price announcement effect. Some points on stock repurchasing: Announcement effects takes place after dividend increases and share repurchases. One of the effects of stock purchases is decrease in dividends and increase in higher stock price. Stocks are purchased at a premium rate by the repurchasing firms. After the completion of repurchase there will be a decline in stock price but remains higher than the pre-purchase price. Dividends and repurchases can be used as signals and under all circumstances neither dominates the other. Dividends convey relatively lesser signal strength compared to repurchases. Reference Mark E. Holder, Frederick W. Langrehr and J. Lawrence Hexter. Dividend policy determinants: an investigation of the influences of stakeholder theory - Special Issue: Dividends. Retrieved 27 August 2006, < http://www.findarticles.com/p/articles/mi_m4130/is_3_27/ai_53649447>. 1998. Read More