Impact of the Change on Share Price - Essay Example

1.0. Impact of the change on share price As earlier noted, one of the critical decisions that managers in corporate firms are concerned about is how profits made in the firm should be distributed to the shareholders and at the same time reinvesting the profit in the firm. This is not only the problem as other issue is how their decision will impact of the share prices. A number of researches have investigated the link between change in dividend policy and volatility of share price at different times (Ali and Hamid, 2011; Anwar and Ahmed, 2010; Henk et al., 2008). Though their findings show inconsistencies with regard to data from Wal-Mart, the results help develop strong conclusion on the relationship between dividend change policy and the share price within a given period of time. Starting the argument brings back the irrelevance of dividend policy as postulated by Miller and Modigliani (1961). As seen earlier, they believe the wealth of shareholders is not affected by the change in dividend policy adopted by Wal-Mart. Bringing this theory with regard to the firm, Wal-Mart chose to distribute its profits as dividends to its shareholders in the last three years with the highest value being in 2012. In so doing, its stock prices will be automatically reduced by the amount of a dividend per share on the ex-dividend date. This argument has been fully supported by Grullon and Miachaely (2012). They created 30 portfolios of common stock in New York Stock Exchange. They intended to study the effect of dividend policy on share price. By using capital asset pricing model for testing expected return and dividend yield, they realized there was association between expected return and dividend yield thus concluding that different changes in dividend policies may lead to different share prices---findings that are inconsistence with irrelevance hypothesis. Basing on the duration effect, it is expected that share price of the firm will be less responsive to fluctuation in discount rate because it has high dividend yield thus having implied near term-cash flow. Therefore what is expected from this firm is an inverse association between share price volatility and dividend yield. In addition to this, arguing from the trend of its rates of return effect, if Wal-Mart had small dividend yield and small dividend payout then it would be possible to assess its valuable than its available assets as a result of its growth potential. Since forecasts of earning from growth opportunity gives more error than prediction or earning from assets in place, Wal-Mart is excluded since it has had high payout and high dividend in the past three years thus lower volatility in its share price. It is at this point that share price volatility and dividend yield, as well as dividend payout are inversely related. This position is consistent with Gordon and Shapiro (1956) model where current stock price in the firm is equivalent to the present value of its future dividends. Their argument is that firm’s dividends constitute a constant fraction of the profits the firm carries out. Thus concluding that the expected dividend act as a representation of investors’ motivation thus shooting the share prices. When firms’ profitability improves, there is an increase in stock price since investors become more optimistic regarding future performance of the firm. To this regard, share prices with high expected profitability will go up much faster than those of firms expected to underperform. Kahle (2010) finds that firm-level stock returns are majorly pushed by cash-flow news. Therefore it is worth arguing that since stock prices are related to past earnings and negatively depend on concurrent earnings, share prices of Wal-Mart are expected to go up if the dividend change policy act in a manner that they pay higher to their investors. However, this argument can be tied to inflation. First, like the case of 2007/2008, impact of inflation on the stock price was not obvious with Wal-Mart. If for instance households expect higher prices, they tend to increase their rates of consumption and thus reducing their savings. This in turn affects share and or stock prices. On the other hand, if the same households keep the value of their heritage, they are likely to invest shares for the sake of hedging against a rise in prices of goods and services. This argument therefore takes the direction that dividend policy change as seen during 2007/2008 inflation and financial crisis. Some cases made households affiliated to Wal-Mart have a hedging purpose which in turn affected the share prices. During its trading period, the firm had mixed interest rates which caused mixed on prices of the stock. As Kahle (2010) notes, if rates go up, then bonds are affected since they become less expensive which makes shareholders make arbitrations for bonds by selling shares they possess thus making prices of stock to go down. This is the same case with Wal-Mart as far as their dividend policy change is concerned. There has been significant increase in interest rates which has been making their investors to buy back equity thus making their share prices to go up. 2.0. Conclusion This research has discussed dividend policy changes in particular Wal-Mart by first assessing possible reasons for it changing its dividend policies and thereafter assessing impacts such changes had on its share price. First, this research shows that there has been evolution on corporate dividend policy. This has been made through review of related theories and made counter arguments on these theories. In attempts to understand dividend policy changes within the realm of Wal-Mart, the research has provided basic argument for these theories which has been supported by empirical evidences to test these them. Secondly, managers from Wal-Mart should be able to change volatility of their share prices by altering their dividend policy. As a matter of fact, it can be possible for the firm to use dividend policy as a tool for altering or controlling their share price. Though this research focused mainly on Wal-Mart, various researches reviewed bring inconsistent results. May be the famous statement of Fisher Black regarding dividend policy, "the harder we look at the dividends picture, the more it seems like a puzzle, with pieces that just do not fit together" (Berk and DeMarzo, 2011 p. 5) is still valid with this particular case. Read More