Aspects of Corporate Financial Policy - Essay Example

Introduction This paper seeks to discuss the ment: “It does not really matter how much dividend how much we pay to our shareholders. Thevalue of their shares is going up so fast on the stock market that they are making enough money irrespective of the dividend.” The paper starts to defend the proposition that dividend policy is irrelevant as described by Miller and will be followed by evidence of such claim. The other side of the coin will take the remaining part with the end view of presenting a balanced analysis as a basis for the conclusion at the last part. The view that dividend does not matter as far as wealth maximization is concerned has its support in the article by Miller (n.d.) entitled “ Do Dividends Really Matter?” In said paper, Miller explained his position about the few aspects of corporate financial policy where academics and practitioners differ on what really is the effect of dividend policy on stock price. He is aware that the academic consensus that dividends do not matter much and that the market should not be expected to increase prices because of “generous” dividend policies. He however admits that generous dividends may cause share to sell lower due to tax penalties or higher taxes on dividends as against capital gains. On the other hand he also knows of the continued claims from corporate officials and investment bankers about the big influence of dividend on market prices because of cited instance where there were jumps in price after some announcements of resumption of regular dividends (Miller, n.d.). One may easily notice what caused the world of academicians to differ from those of practitioners. It may be asserted the academicians seem to view things from a long term point of view while practitioners will look at it at the immediate reaction from the market which is rather a short term point of view. This must be so since academicians would most probably believe in the result of researchers than a knee-jerk reaction to what happens in a certain stock market. Practitioners in turn would like to be guided by academicians but not necessarily. Indeed Miller saw what practitioners perceived as “an optical illusion” where he used as an example with his students a stick in the water to illustrate his point. He explained that of one who uses his or her eyes and look at the stick in the water, it appears bent yet if one feels it with his or her finger or if one pulls it out of the water one will realize that the stick is not really bent. It is just the looks of it that is bent. He thus argued that same illusion happens with dividends which do not actually affect the value of stock although they appear to be so if one will not think have a deeper reflection of one’s observations more deeply. Miller traced the illusion to academic journals that have appeared years earlier about two decades ago. The first of this journal was of course directed to the issue of dividend by explaining that as a matter of economic theory, that dividends and value are not related as matter of expectation. This is what the author equated as the stick that is not actually bent. He admitted writing the first article entitled “Dividends, Growth and Valuation of Shares” jointly with Professor Modigliani for the University of Chicago. His argument was premise on the fact speaking only of a firm’s dividend policy is one sided. He explained that the source of where to get money to pay dividend must be there. By his logic the use must be equal to the source in the same way that total debits must be equal to credit as use in the accounting parlance (Miller, n.d.). The payment by a company of a dividend indicates a use of funds must be balance by the source. His joint paper with Modigliani argued that if one holds constant the use which represented by the capital budget of the, such is investment spending and such would require raising more funds which could come from bank loans or other sources which could selling stocks or bonds (Miller, n.d.). He explained that a firm’s decision on dividend policy given its investment policy is really a choice of financing strategy where company will have to choose to finance its growth through heavier reliance on external sources or by cutting or delaying its dividend and thus rely more on internal funds (Miller, n.d.). It may observed sound that since dividend is finance strategy and therefore adopted as a matter of choice then it should be logical to see a consequence of that choice on the matter of either benefit or cost to the decision maker on the ground that a choice has a consequence. It may be counter argued that if a firm does cut back its present level of dividends then it should be reinvesting said funds which promises the company a higher return that its opportunity cost or cost of capital. It could not be that a firm does the cutting back for no reason. In a typical company the issue of cash flow is a reality and one’s mismanagement of its cash flow could cause some liquidity problem and liquidity problem could be a working capital problem. To illustrate, there is a difference between having money and not having money to service currently maturing obligations and pay the salaries of employees. Failure on this could cause the creditors not wanting to continue doing business or worse they could petition for bankruptcy and this could cause cessation of operation. From an investors’ point of view, it may be asserted that failure to manage cash flow caused by failing to decide correctly on dividend policy could bring risk to the company and hence the stock price must be affected as a result. Finance theory concurs with the argument that the investors want to be compensated with higher risks of doing business. Miller still asserted his way by saying what is clear is the lack of basis that a generous dividend or outside financing as is assured as the best or the other way around. Miller’s main point is that it is the investment policy and not the finance strategy that drives stock prices but as was counter argued, would one still make a choice of finance strategy if there is no benefit from that choice? Miller concluded by hating to sound negative and he explained his point that as a result of this position about the irrelevance of dividend policy to stock price, it cannot be taken therefore seriously as an effective management tools which could be much of use in a world he characterized by rational expectations (Miller, 1986). He would rather prefer that managers concentrate on investment decision and other management function such as production, human resource or personnel as well as marketing and research decisions that would support these very important investment decisions, which he referred by the economists’ language to be the real side since it is in there where companies generate current and future cash flow which are the ones that count (Miller, n.d.). What are the researches that support Miller for the irrelevance of dividend policy? Frankfurtera and Wood Jr. (2002) appear to agree with Miller as they found irrelevance of the dividend policy. They noted that the issue of dividend policy has created rigorous studies by economies that produced several academic modelling and testing by experiments yet up to this point conflicts on these models are still lacking strong empirical support in trying to explain whether indeed dividend policy causes changes in stock price. The authors’ purpose in conducting their research is the determination of method employed, data frequency and sample period on whether these could explain the inconsistency of report and they found that there is no dividend model that is supported consistently (Frankfurtera and Wood Jr., 2002); hence, dividend policy does not influence stock price. It should be noted that Frankfurtera and Wood Jr. were just trying to verify the work of others and not making their own research. What are the research that support the about the relevance of dividend policy? Not everybody however agree with the claim of Miller. In a paper by Johnsona, et. al (2006), they found relevance of dividend policy when they tested predictions of dividend signalling models by the use of close-end equity which possessed clear policies that guarantee dividends. They found that said policies were aimed to reduce share price under valuation in relation to net asset value (NAV). They found that when the respondents companies use or adopt minimum dividend policies has undergone reduced price discounts or that price are higher than used as compared to others. They have also show such dividend policies to have resulted to smaller discounts than other funds which still indicate higher prices with the dividend policy. Greater excess returns were also noted in addition to result of having their managers to stay longer than others. It is presupposed that managers are given incentives in one way or the stock through these stock dividends (Johnsona, et. al, 2006). The fact the these authors found relationship of high quality close-ends funds in reducing under valuation through dividend policy should be a great boost to the claim about the importance of dividend policy in the stock price. Again it may be argued that the researchers may be just talking of short term reaction. Although based on actual data and these recorded observations may turn out to be optical illusion as believed by Miller. This paper can only believe that the methods used by this latest research are valid to show credence to their findings. Other authors also found some validity of the relevance of dividend policy. Ang et. al (1997) who investigated the capital structure and dividend policies of a sample of large publicly traded companies in Indonesia found respondent companies to have good access to various source of funds including equity market and banks. They further found absence of evidence relating problems associated with asymmetry of information with the banks. This means that these companies who responded expect fair assessment from banks about their future prospect when they apply for financing and for which reason they could avail of low interests on their loans plus the commitment from banks to assist sample companies in the event of insolvency. Nevertheless, Ang et. al (1997) found some support that companies have in fact operated under a seeming optimum debt ratio or capital structure. What made their findings relevant is their characterization of some of the respondents which include large profitable firms that do not have a problem on their sources of funds. In other words, these companies are given choices in their finance and investment strategies where they could engage on margin financing. In such practice they could borrow more just to increase their earnings. There is of course increased risk in additional borrowing. This is therefore consistent with seeming observation of optimal debt ratio since increased earnings as reflected in higher stock price is associated with borrowing. Dividend policy must be deemed directly linked under this setting since opting not to declare dividends now is an opportunity to margin financing that could in effect increase earnings. Although the authors claim confirmation of survey data by their regression results, which indicate validity of observed data, the authors sound not to be fully convinced about the assured effect of dividend policy. It may be noted that statistical analysis allow margin of error and the fact that their finding is closer to supporting than non supporting the relationship of dividend policy to stock price then it should be taken by the limitation of its claim. It must be emphasized that the existence of an optimal debt ratio or capital structure is an indication that the timing of when to declare and when not to declare is an issue if one is interested in the corporation’s wanting to have a high stock price for the company. Such capital structure could only need to include dividend policy as a part. Ang investigated the capital structure and dividend policies of sample of large publicly traded Indonesian firms. Their reason to make Indonesia a better candidate to test financial theories is the liberalizations programs applied in the said country since 1983. Hence they argued that the survey they conduced has the advantage of management perception emphasis because the policies of the respondents were more forward looking and more oriented towards choices at the margin and more capable of responding to hypothetical “what if” questions. Ang, et. al (1997) found in their results that the companies have indeed good contact to diverse funds sources such as the banks and equity market. They found too that companies surveyed had their bank loans preferred for short or medium range of one to five years and that financing source their supplier and foreign sources had their significant roles. They also noted the fact of preference for retained earnings are preferred source over wide range of scenarios but they found that such fact alone is insufficient to justify pecking order model of Myers. Said theory maintains the internal sources are preferred over debt financing and debt financing is preferred over equity financing (Constantinides, et al, 2003). Would a created model for dividend policy be confirmed by an empirical test? In answer, Cyert et. al (1994) constructed a dynamic model of dividend policy using some ingredients of behavioural theory as bases. They described the optimal dividend policy and as one generating restrictions to the likelihood of future dividend changes. Such is an indication for the need for stability in the dividends and hence dividend policy is relevant. Since the restrictions generated are with respect to various financial and real variables including investments and dividends that influence economic earning evolution of companies, a test was needed to confirm results. When the authors tested their relations using NYSE dividend date, they found that results are accommodating the prediction of the behavioural model they created (Cyert et. al 1994). This is another research finding that support the possibility of an optimum dividend policy (Goshen, 1995; Gertier and Hubbard, 1993). The said dividend policy relevance is still find support in the work of Lasfer (1996) who found evidence in experience on the simultaneous effects of both corporation and personal individual income taxes in relation to dividend payment adjustments. In addition it was shown that respondent companies set their policies relating to dividend with purpose of minimizing their tax liability while at the same time maximizing the value of stock for the stockholders. The author particularly cited firms failing to deduct the advanced corporate tax from tax liabilities were found to pay low dividends (Lasfer, 1996). There is empirical evidence on the simultaneous effects of both corporation and personal income taxes on dividend payment adjustment and the behaviour of share prices on the ex-dividend dates. Since the results show that companies set their dividend policies to minimize their tax liability and to maximize the after-tax return of their shareholders. This is indeed a very strong indication about the relevance of the dividend policy on stock price. The work of Lasfer could not be separated from the tax preference theory, which is grounded on the belief that investors might prefer a low dividend payout to a high pay-out. Long-term gains are taxed at a lower rate where as cash dividend income is taxed higher, thus the preference of retaining investment for reinvestment. Taxes are not paid on the gain until a stock is sold. No capital gains if holder including all beneficiaries if investor or holder dies with the stocks (Brigham and Houston, 2002). Its direct connection with tax preference theory could still establish evidence of relevance of dividend in influencing management as the latter try to maximize shareholders’ value (Van Horne, 1992; Weston and Brigham, 1993). The theory of dividend relevance to stock price still finds another support in the work of Wu (1996) who examined the effect of differential taxation on corporate dividend policy. He found about the presence of structural shifts in the aggregate dividend pay-out coinciding with tax law changes. The author further found support to the hypothesis that eliminating the preferential capital gains tax causes impact that is positive in nature on aggregate corporate dividend payout (Wu, 1996). Still another support for the relevance of dividend policy is found. In the work of Daniel (2008), he found that dividend-paying firms have the tendency to manage earnings upward when their earnings would otherwise fall from expectations but such findings was noted evident only in firms with positive debt and was more aggressive before the Sarbanes-Oxley Act of 2002 and where firms’ CEOs have higher dollar dividends and higher performance-pay sensitivities and less outside equity financing. Researcher’s findings have the implication of treating expected dividend levels as an important earnings threshold. Again, this is very clear evidence that dividend policy matters to managers. An evidence of support is found in the work of Baker, et. al (2006) who surveyed Norwegian firms’ managers on their views on dividend policy. Their findings were not conclusive about the key factors that affect dividend policies. What they used as factors in influencing dividend policies in their survey include expected future earnings, stability of earnings, and degree of financial leverage and liquidity constraints. Norwegian managers were discovered to have mixed views whether dividend policies affect the firm value. Researchers saw a basis for payout policy but not tax-preference explanation. What could be taken from this paper is that dividend pay-out policy was found relevant independent from tax-preference explanation. This means that dividend policy still matters. The principal conclusion of the dividend relevance theory is that dividend policy does affect the required rate of return on equity. Gordon and Lintner argued strongly that return on equity decreases as the dividend pay-out is increased because investors are less certain of receiving capital gains which will come as result of retaining earnings than receiving dividend payments (Brigham and Houston, 2002). Gordon and Lintner argued further that investors value a dollar of expected dividends more highly than a dollar of expected capital gain because the dividend yield component is less risky than the g component in the total expected return equation, ks = D1/P0 + g. But Miller and Modigliani (MM) disagreed saying the Ks are independent of the dividend policy (Brigham and Houston, 2002). MM called it a bird-in-hand fallacy because in their view, most investors plan to reinvest dividends in the stock of the same and similar firms, and that in any event, the riskiness of the firm’s cash operating flows, not by the dividend pay-out policy (Brigham and Houston, 2002). Despite calling such claim as a fallacy many managers or practitioners believe its power and they have shown some research to back up their beliefs. To say still that dividend policy relevance still an optical illusion as described by Miller may sound to be an understatement of reality. Conclusion: Dividend policy does matter in relation to stock price in certain instances as evidenced from some researches despite insistence of academicians that it does not. This researcher cannot close eyes to what were tested empirically on the basis of reactions of respondents from research works cited here. The paper started with the hypothesis that the dividend policy is irrelevant to stock price using Miller’s assertion that it was the academicians that believe first the proposition and that it was the practitioners who were telling a different story. From the materials cited, only one work supported the work of Miller while the rest does not convincingly agree with him and therefore believes that dividend policy is still relevant. From those who believe in the relevance of the policy at a certain point, they were taking from empirical experiences of those decision makers who would most likely suffer the consequences of their decisions in terms of losing their jobs or their investments. From the practical side, the belief that it is relevant just keeps on persisting in some other ways. To reconcile Miller and those who oppose him is the fact that the academicians look at it from the long-term point of view while the practitioners look at it from the short-term point of view. No wonder Miller was saying it was an optical illusion and that although it is an illusion; managers are still affected and swayed by its importance of the policy because they are the one that makes the decision of the floor and in the market. The position taken by Brigham and Houston (2002) also offers a good way to reconcile the seeming conflict. The authors who explained the need to test the claims against opposing theories empirically but results have been unclear for two reasons. Their first reason was that a valid statistical test requires holding things other than dividend policy to be constant, which is, companies must differ only in dividend policies. Their second reason was that the researcher must be able to measure with high degree of accuracy each respondent’s cost of equity. Brigham and Houston (2002) told that neither of the two conditions holds. Thus, the resulting unclear relationship between dividend policy and the cost of equity even up to this point. This conclusion also explains the fact that investors cannot be seen preferring for higher or smaller dividends but evidence and logic point to the reality that investors strongly prefer stable and predictable dividend policy (independent of the pay-out level (Brigham and Houston, 2002). References: Ang et. al (1997) Capital structure and dividend policies of Indonesian firms, Pacific-Basin Finance Journal Baker, et. al (2006) How Norwegian managers view dividend policy, Global Finance Journal, Elsevier Brigham and Houston (2002) Fundamentals of Financial Management, Thomson South-Western, London, UK Constantinides, et al (2003), Handbook of the Economics of Finance; Elsevier Cyert et. al (1994) Managerial objectives and firm dividend policy A behavioural theory and empirical evidence, Journal of Economic Behaviour & Organization, Elsevier Daniel (2008) Do firms manage earnings to meet dividend thresholds, Journal of Accounting and Economics, Elsevier Frankfurtera and Wood Jr. (2002) Dividend policy theories and their empirical tests, International Review of Financial Analysis, North Holland Gertier and Hubbard (1993) Corporate Financial Policy, Taxation, and Macroeconomic Risk; Rand Journal of Economics, Vol. 24, 1993 Goshen (1995) Shareholder Dividend Options; Yale Law Journal, Vol. 104, 1995 Johnsona, et. al (2006), Dividend policy, signalling, and discounts on closed-end funds, The Journal of Financial Economics, Elsevier Lasfer (1996) Taxes and dividends - The UK evidence, Journal of Banking & Finance, Elsevier Miller (n.d.), Do Dividends Really Matter?; Graduate School of Business The University of Chicago Miller, M (1986) Behavioural Rationality in Finance: The Case of Dividends; The Journal of Business, Vol. 59, No. 4, Part 2 Van Horne (1992) Financial Management and Policy, Prentice-Hall International, London, UK Weston and Brigham (1993) Essential of Managerial Finance, Dryden Publishers London, UK Wu (1996) Taxes and dividend policy, International Review of Economics and Finance, JAI Press Inc. Mesg to the writer: To be honest, I think most of the sentences are too long and too complicated. Can you pls make them as simple as possible and straight to the point? There are a lot of complicated sentences used in the work, which is just too much for the reader. As long as you state your argument clearly, it is fine. Pls don’t go for complicated sentences or very long ones. Tks! The assignment is not about critically analysing those articles. We’re asked to read around to find evidences to support our argument i.e. if we think it doesn’t really matter how much dividend companies pay to their shareholders, we have to say why and give evidences e.g. this author said this and that … You just need to use the points/evidences from the article to support your own view. And you need to put some sentences, which looks like your own view and at the same time put down the points from the articles to back up your view. When I read through the work, I just felt that it’s just the summary from those articles. Comment: You said that I just use the points from the articles to support my view? did I not do by taking the most important part of the article which you refer as summary? The assignment is about discussing the statement and giving your viewpoint i.e. whether you think it matters or it doesn’t matter how much dividend we pay to our shareholders. You can argue from both sides and you need to put down what you think of this statement, not just summarising the points from the article. And you’ve got to give some numerical examples (e.g. financial yahoo or news in the newspaper) and empirical evidence (I think empirical examples are example outside the theries. They are like practical examples.) And I can’t fine any of them in the work! All I found was the points from those articles. Comment: Some of the cited articles are research works and their subjects of studies are best are best illustrations of empirical evidence as they are tested. They are examples of outside theories because they are result of research. A news items that is not a result of research would be just hearsay and therefore not an example. If you do take the full sentences from articles without changing them around, please remember to put quotation marks to avoid plagiarism. I chose to paraphrase hence do direct quote. Can you please try to keep the work within the word limit 3, 500? Thank you. I can’t find the full references for Brigham and Houston (2002)! Please double check. Can you pls go through the work properly? As some of the words seem to be either missing or repeated. And some of the sentences didn’t flow. This assignment is very important and for the money that I have paid. Really I think there shouldn’t be any mistake in there. When I found a mistake in the statement in your first paragraph, I was like … I don’t know .. pls be understood that for the money I paid, there shouldn’t be a mistake like that. Because it shows that you didn’t go through the work properly before sending it. Also, can you tell me the date, which the company contacted and asked you to stop working on it? Was it the day before the original deadline? Or it was many days before that? I just have a feeling that their stupid action did affect the quality of the work and it’s not fair on me for the amount I’ve paid. They didn’t give me a call before doing that. It’s giving me extra stress now. I hope you can understand my point and revise the work accordingly. Comment: I cannot also remember and the message seems to be unclear. As for me I always give my best for my clients. Some errors are still committed along the way unintentionally because of so many factors like accidental pressing of one key which could change a letter in one of words and then accidentally saving it. This is happened in the first part. To repeat your need for examples are cited in the research works analyzed and presented. I cannot invent or present news without having to another empirical research which is not the nature of this paper. I have improve the paper especially on those you marked. I hope this paper would be ok now to you. Thanks Writer 1259, P.S. Just delete then these comments at the last . I intended to leave it here for communication purposes. Read More