Dividends are sums of money paid to shareholders out of profits. In the UK dividends are usually paid out twice a year, there is an interim dividend half way through the year and a final dividend after the AGM. Dividends are only paid out of accumulated distributable profits and not out of capital, mainly to protect creditors.
There are many academics that argue that shareholder value is based around the market value of the shares. With the assumed business purpose of shareholder wealth maximisation. Arguably, the best way of maximising shareholder wealth is through capital gains by increasing the share price. Considering this, does dividend policy affect share price?
The answer to that question is yes, although some may argue that share price is not affected by dividends, if you consider the signalling effect, I believe it is clear that actually dividends can affect share price. The signalling effect is a result of information that is released which sends a signal as to the performance and position of the company. If we consider for example, if a company has continually paid dividends to it's shareholders, but suddenly announces that no dividends will be paid in the financial year, the signal that shareholders will receive is that the company is not performing well. Following this information, the share price will drop and vice versa.
However, there are arguments that state that dividend policy has no effect on shareholder value. This is because when a firm decides to distribute the remaining profits to shareholders through dividends, the stock price will be automatically reduced by the amount of a dividend per share on the ex-dividend date. So in a perfect market, dividend policy does not affect shareholder wealth.
There are many arguments surrounding dividend policy and shareholder value but I believe that dividend policy does affect shareholder value.
Saturday, 22 March 2014
Saturday, 15 March 2014
Capital structure: is there an optimum gearing level?
The tradition view of capital structure was that firms should increase gearing from a low level because the firm would be financed by cheaper borrowed funds, therefore the weighted average cost of capital would fall. By doing so the discounting of future cash flows at the lower WACC produces a higher present value and so increases shareholder wealth. So arguably if the aim of the firm should be to maximise shareholder wealth, the view regarding capital structure is that the WACC should be the lowest it can possibly be, right? Well, no.
There are many advantages to debt, the obvious being the costs, but there is also tax relief because interest is deducted from the profit and loss. However, the decision reaches and impasse, by increasing debt, and thus increasing interest, the WACC goes down, which increases the market value of the firm. However, by increasing interest, there is less left in the pot for dividends to shareholders so you are decreasing shareholder wealth! Problems with dividends carries even further if the firm has a bad year, because the interest must be paid regardless of the firm's performance, the volatility of dividends will increase. Furthermore, the increase in volatility also increases the risk to the shareholders, therefore, in the concept of fair return for the risk, the dividends should be increased, which increases the WACC.
So, bearing all this in mind, is there an optimum gearing level?
The traditional theory regarding the cost of capital assumes that the WACC is U shaped, so there is an optimum gearing level. However, there are too many complicating contextual factors to take into consideration for different companies and therefore an optimum level of gearing cannot be established for each company, which explains why there are so many different gearing ratios amongst companies.
There are many advantages to debt, the obvious being the costs, but there is also tax relief because interest is deducted from the profit and loss. However, the decision reaches and impasse, by increasing debt, and thus increasing interest, the WACC goes down, which increases the market value of the firm. However, by increasing interest, there is less left in the pot for dividends to shareholders so you are decreasing shareholder wealth! Problems with dividends carries even further if the firm has a bad year, because the interest must be paid regardless of the firm's performance, the volatility of dividends will increase. Furthermore, the increase in volatility also increases the risk to the shareholders, therefore, in the concept of fair return for the risk, the dividends should be increased, which increases the WACC.
So, bearing all this in mind, is there an optimum gearing level?
The traditional theory regarding the cost of capital assumes that the WACC is U shaped, so there is an optimum gearing level. However, there are too many complicating contextual factors to take into consideration for different companies and therefore an optimum level of gearing cannot be established for each company, which explains why there are so many different gearing ratios amongst companies.
Saturday, 8 March 2014
Is crowdfunding effective?
Crowdfunding is the process of raising money for a project, usually small amounts from a large number of individuals, via a platform, usually the internet.
Crowdfunding has ballooned in the past decade, mainly because of the platform to society that the internet provides, not only through crowdfunding platforms such as Kickstarter, but also through social networking. The platforms use a system whereby the user submits a business plan and legal documents. The user, whether looking to create a new business, or a new project, or expand on something that is already established, they must create an inviting business plan to attract potential donors.
The audience for these platforms are stakeholders and potential customers, usually the user will offer some sort of product or service in return for a donation at a minimum price. Essentially most of the projects on Kickstarter are products that can be pre-ordered, however, if the project fails you don't receive a refund! These crowdfunding online platforms are extremely successful, by 2012, nearly 3 million people had donated and helped a total of 30,000 projects meet their fund-raising total. Kickstarter up until 2012 had seen around $300million in pledges! Platforms like Kickstarter and Indiegogo are letting designers and creative minds connect with audiences who want to finance their dreams.
A good business plan will usually guarantee you reach the fund-raising target, but after you reach your target with the money is where the problem begins! Once they have the money, they have to get started with their project, with hundreds if not thousands of people watching your every move. The backers are putting their faith in the project leaders and when the project doesn't follow the timeline things can get shaky and backers can get impatient.
One Kickstarter project started by Eric Migicovsky, was creating a new design of watch, it raised more than $10 million in pledges and there were essentially 65,000 who had pre-ordered a watch that did not exist. Mr Migicovsky eventually had to hire someone to manage his inbox and to post updates regarding the project, nearly 9,000 people had emailed him.
The issue regarding the relationship of backer and project leader is still hazy and is something that is being worked on at the moment in time. The donors are not investors, or customers, although they may receive the product, they are not protected by consumer laws. Its extremely unclear and needs to be approached and something put in place.
However, with this in mind, the success of the platforms is undeniable, and the users on these platforms are aware of the risk they undertake. I believe the platforms are a brilliant idea and a creative way of taking advantage of the stage the internet offers.
Crowdfunding has ballooned in the past decade, mainly because of the platform to society that the internet provides, not only through crowdfunding platforms such as Kickstarter, but also through social networking. The platforms use a system whereby the user submits a business plan and legal documents. The user, whether looking to create a new business, or a new project, or expand on something that is already established, they must create an inviting business plan to attract potential donors.
The audience for these platforms are stakeholders and potential customers, usually the user will offer some sort of product or service in return for a donation at a minimum price. Essentially most of the projects on Kickstarter are products that can be pre-ordered, however, if the project fails you don't receive a refund! These crowdfunding online platforms are extremely successful, by 2012, nearly 3 million people had donated and helped a total of 30,000 projects meet their fund-raising total. Kickstarter up until 2012 had seen around $300million in pledges! Platforms like Kickstarter and Indiegogo are letting designers and creative minds connect with audiences who want to finance their dreams.
A good business plan will usually guarantee you reach the fund-raising target, but after you reach your target with the money is where the problem begins! Once they have the money, they have to get started with their project, with hundreds if not thousands of people watching your every move. The backers are putting their faith in the project leaders and when the project doesn't follow the timeline things can get shaky and backers can get impatient.
One Kickstarter project started by Eric Migicovsky, was creating a new design of watch, it raised more than $10 million in pledges and there were essentially 65,000 who had pre-ordered a watch that did not exist. Mr Migicovsky eventually had to hire someone to manage his inbox and to post updates regarding the project, nearly 9,000 people had emailed him.
The issue regarding the relationship of backer and project leader is still hazy and is something that is being worked on at the moment in time. The donors are not investors, or customers, although they may receive the product, they are not protected by consumer laws. Its extremely unclear and needs to be approached and something put in place.
However, with this in mind, the success of the platforms is undeniable, and the users on these platforms are aware of the risk they undertake. I believe the platforms are a brilliant idea and a creative way of taking advantage of the stage the internet offers.
Saturday, 1 March 2014
Does agency theory apply to family firms?
Are there differences between the goals of the family run management of the firm and the shareholders?
What I am assuming is that the firm is owned by family and partially by shareholders, and what I want to discuss is whether the goals of the family management and the shareholders are aligned. For example, Walmart was created by the Walton family and currently, three family members sit on the board, one of them is the chair and they have a majority stake in the company, so how do the external shareholders ensure that the goals of the family and of the shareholders are aligned?
It seems that family managed firms are overlooked by literature regarding agency theory. It is arguably because owner-managed firms need not necessarily incur large agency costs because surely if the firm is managed by the owners then goals are aligned? So why do most family run firms offer pay incentives and use other formal governance techniques to ensure firm performance? T
he original work on agency theory seems to assume that owner-managed firms are not at risk to agency theory because their goals should be aligned, however, this is not always the case. In face, private ownership and owner-management not only reduces the effect of external controls, but also exposes a firm to self-control, whereby owners are overcome by incentives that encourage them to make decisions that not only harm themselves but others around them. Furthermore, family managed firms are at risk of adverse selection because of the effect of private ownership on labour markets.
What I am assuming is that the firm is owned by family and partially by shareholders, and what I want to discuss is whether the goals of the family management and the shareholders are aligned. For example, Walmart was created by the Walton family and currently, three family members sit on the board, one of them is the chair and they have a majority stake in the company, so how do the external shareholders ensure that the goals of the family and of the shareholders are aligned?
It seems that family managed firms are overlooked by literature regarding agency theory. It is arguably because owner-managed firms need not necessarily incur large agency costs because surely if the firm is managed by the owners then goals are aligned? So why do most family run firms offer pay incentives and use other formal governance techniques to ensure firm performance? T
he original work on agency theory seems to assume that owner-managed firms are not at risk to agency theory because their goals should be aligned, however, this is not always the case. In face, private ownership and owner-management not only reduces the effect of external controls, but also exposes a firm to self-control, whereby owners are overcome by incentives that encourage them to make decisions that not only harm themselves but others around them. Furthermore, family managed firms are at risk of adverse selection because of the effect of private ownership on labour markets.
There are also issues because family firms may be stubborn in what they stand for, perhaps arising from the company's history, which is no longer relevant in the market and could be causing drift. Also, what if the firm appoints a family member who is not suitable for the role within the company but because he is a member of the family he will not be dismissed?
How can shareholders overcome these problems? Well they do have voting rights so they can make their opinion clear but if the family owns the majority shares then it becomes redundant. This creates a problem and families must accommodate shareholders opinions if they wish to raise capital for expansion and growth through equity finance.
There are several issues that shareholders can face in family owned firms, the fact that family owned firms are considered to not have agency problems seems ridiculous.
Saturday, 22 February 2014
Do mergers and acquisitions create value?
With all of the publicity surrounding company takeovers and companies joining together it is imperative to discuss the topic of whether or not mergers and acquisitions create value.
A merger is the combination of two business entities under common ownership. An acquisition is where a business entity engulfs another and takes ownership and managerial control. Differentiating between these two acts in real life cases has proven to be difficult and it has even been suggested that it is impossible to classify the relationships within the combined entity as a merger or a takeover. Such as the case of Unilever, where they bought a majority stake in a water purification company, Qinyuan. Although Unilever holds the majority stake in the company the chief executive of Qinyuan is keeping his position, which makes it difficult to distinguish whether or not it is a "takeover" or a merger. Therefore, I am going to discuss the value of mergers and acquisitions combined.
Firstly, I think its appropriate to acknowledge the motives behind mergers and acquisitions:
To understand whether or not mergers or acquisitions add value to the entity we must consider different parties within the company. Mainly, stakeholders and managers. The essence of mergers and acquisitions, within capitalism, is too create value for the shareholders of the acquiring firm. However, various studies have examined whether acquisitions create value, and they have found that the target shareholders generally fare pretty well, while most acquisitions fail to create value for the acquirers. This is represented by the share price movement when the acquisition or merger is announced. Studies have concluded that the share price of the target company usually go up substantially, whilst the share price of the bidding company either experiences no increase or a reduction.
Of course the share price after the announcement is short-term and to look at shareholder value we must look at long-term value. A study by Hazelkorn and Zenner found that over the long-term, acquirers tended to slightly outperform their industry peers. They also stated that obviously some acquisitions create great shareholder wealth and others diminish it. It is down to whether or not the acquisition is successful.
For example, the merger of AOL and TimeWarner is probably one of the biggest failures in recent business history. In 2001 the deal was crowned "the deal of the century", in 2002 AOL had 26 million dial up customers and in 2009 it had 5.4 millions. Vast amounts of shareholder wealth was destroyed and the two eventually became separate entities in 2009.
However, in the case of mergers and acquisitions, success can be dependent upon the capabilities of the acquirer. For example, when Jaguar and Land Rover were under the ownership of Ford, up to 2008 they were struggling, and Ford was seeking financial assistance for the two companies and made the decision to sell them. Ford originally paid £1.6bn for Jaguar and £1.7bn for Land Rover in 1989 and 2000 respectively. Ford sold both businesses to Tata Motors for £1.15bn in 2008. Many analysts believed Tata Motors to be "round the twist". They are now eating there words as in 2013 Jaguar Land Rover was estimated to be worth around $16bn! This is down to successful leadership and extremely good decision-making from Tata Motors.
So do mergers and acquisitions create value? This is all down to whether or not they are successful (obviously). How do you generate a successful merger or acquisition? This is down to the capabilities of the leaders and the management. In the case of Ford the acquisitions were diabolical, whereas under Tata Motors, who took a very different approach to the company, it has become a roaring success. The success of mergers and acquisitions is not down to chance, but down to excellent decision-making!
A merger is the combination of two business entities under common ownership. An acquisition is where a business entity engulfs another and takes ownership and managerial control. Differentiating between these two acts in real life cases has proven to be difficult and it has even been suggested that it is impossible to classify the relationships within the combined entity as a merger or a takeover. Such as the case of Unilever, where they bought a majority stake in a water purification company, Qinyuan. Although Unilever holds the majority stake in the company the chief executive of Qinyuan is keeping his position, which makes it difficult to distinguish whether or not it is a "takeover" or a merger. Therefore, I am going to discuss the value of mergers and acquisitions combined.
Firstly, I think its appropriate to acknowledge the motives behind mergers and acquisitions:
- Synergy - The company will have a greater value combined than separate.
- Market power
- Economies of scale
- Entry to new markets and industries
- Internalisation of transactions - Improving efficiency!
- Tax advantages
- Risk diversification
- Bargain buying
- Inefficient management - The management of the acquiring company is much more capable than that of the "acquiree".
- Undervalued shares
- Managerial motives
- Survival
- Free cash flow
- Third party motives - Advisers, suppliers and customers!
To understand whether or not mergers or acquisitions add value to the entity we must consider different parties within the company. Mainly, stakeholders and managers. The essence of mergers and acquisitions, within capitalism, is too create value for the shareholders of the acquiring firm. However, various studies have examined whether acquisitions create value, and they have found that the target shareholders generally fare pretty well, while most acquisitions fail to create value for the acquirers. This is represented by the share price movement when the acquisition or merger is announced. Studies have concluded that the share price of the target company usually go up substantially, whilst the share price of the bidding company either experiences no increase or a reduction.
Of course the share price after the announcement is short-term and to look at shareholder value we must look at long-term value. A study by Hazelkorn and Zenner found that over the long-term, acquirers tended to slightly outperform their industry peers. They also stated that obviously some acquisitions create great shareholder wealth and others diminish it. It is down to whether or not the acquisition is successful.
For example, the merger of AOL and TimeWarner is probably one of the biggest failures in recent business history. In 2001 the deal was crowned "the deal of the century", in 2002 AOL had 26 million dial up customers and in 2009 it had 5.4 millions. Vast amounts of shareholder wealth was destroyed and the two eventually became separate entities in 2009.
However, in the case of mergers and acquisitions, success can be dependent upon the capabilities of the acquirer. For example, when Jaguar and Land Rover were under the ownership of Ford, up to 2008 they were struggling, and Ford was seeking financial assistance for the two companies and made the decision to sell them. Ford originally paid £1.6bn for Jaguar and £1.7bn for Land Rover in 1989 and 2000 respectively. Ford sold both businesses to Tata Motors for £1.15bn in 2008. Many analysts believed Tata Motors to be "round the twist". They are now eating there words as in 2013 Jaguar Land Rover was estimated to be worth around $16bn! This is down to successful leadership and extremely good decision-making from Tata Motors.
So do mergers and acquisitions create value? This is all down to whether or not they are successful (obviously). How do you generate a successful merger or acquisition? This is down to the capabilities of the leaders and the management. In the case of Ford the acquisitions were diabolical, whereas under Tata Motors, who took a very different approach to the company, it has become a roaring success. The success of mergers and acquisitions is not down to chance, but down to excellent decision-making!
Saturday, 15 February 2014
Foreign direct investment
Firstly, what is foreign direct investment (FDI)?
It is the purchase of physical assets or a significant amount of the ownership of a company in another country to gain a measure of management control. Firms that make FDIs typically have a significant degree of influence and control over the company in which the investment is made. Open economies with skilled workforces and good growth prospects attract large amounts of FDIs.
China is an example of the success of FDI. From 1978 to 2005 China has an economic growth rate of 9% on average. This is essentially down to the adoption of initiatives encouraging inward FDI. So obviously economies can be successful by accepting FDI, there are many reasons why China encouraged FDI. FDI offers the ability to obtain overseas resources, increase access to return markets, increase local capital markets and drive economic growth. The final advantage of FDI has clearly resonated in China! In the case of China, one of the biggest gains from FDI is the expansion of China's manufacturing exports. The numbers speak for themselves, in 1980 China was ranked 26th in the world for exports, and in 2005 China was ranked 3rd!
It all seems like nothing can go wrong with foreign direct investment in developing economies but examining further there are negative impacts.
FDI can create adverse effects on local competition because of the spending power of MNCs. Also the government will usually give in to the requests of the MNC, loosing national autonomy. There are other contextual factors such as environmental damage, human rights implications and corruption. In my opinion the biggest losers in foreign direct investment are the domestic small businesses. There are people that argue that FDI does not positively affect the host countries and they state that, for the purpose of long-term economic growth, it may be better to protect domestic infant industries rather than rely on foreign capital.
On the other hand, there have been studies that show that MNCs can be good for domestic business and that FDI benefits domestic companies in the same sector and in the upstream sectors initially, before the MNCs become dominant. My question is what happens to the domestic businesses when the MNCs do become dominant?
Perhaps, these are the stakeholders that the government and the MNCs should consider protecting in someway?
It is the purchase of physical assets or a significant amount of the ownership of a company in another country to gain a measure of management control. Firms that make FDIs typically have a significant degree of influence and control over the company in which the investment is made. Open economies with skilled workforces and good growth prospects attract large amounts of FDIs.
China is an example of the success of FDI. From 1978 to 2005 China has an economic growth rate of 9% on average. This is essentially down to the adoption of initiatives encouraging inward FDI. So obviously economies can be successful by accepting FDI, there are many reasons why China encouraged FDI. FDI offers the ability to obtain overseas resources, increase access to return markets, increase local capital markets and drive economic growth. The final advantage of FDI has clearly resonated in China! In the case of China, one of the biggest gains from FDI is the expansion of China's manufacturing exports. The numbers speak for themselves, in 1980 China was ranked 26th in the world for exports, and in 2005 China was ranked 3rd!
It all seems like nothing can go wrong with foreign direct investment in developing economies but examining further there are negative impacts.
FDI can create adverse effects on local competition because of the spending power of MNCs. Also the government will usually give in to the requests of the MNC, loosing national autonomy. There are other contextual factors such as environmental damage, human rights implications and corruption. In my opinion the biggest losers in foreign direct investment are the domestic small businesses. There are people that argue that FDI does not positively affect the host countries and they state that, for the purpose of long-term economic growth, it may be better to protect domestic infant industries rather than rely on foreign capital.
On the other hand, there have been studies that show that MNCs can be good for domestic business and that FDI benefits domestic companies in the same sector and in the upstream sectors initially, before the MNCs become dominant. My question is what happens to the domestic businesses when the MNCs do become dominant?
Perhaps, these are the stakeholders that the government and the MNCs should consider protecting in someway?
Saturday, 8 February 2014
Should companies hedge against foreign currency risk?
To consider whether companies should hedge, we must first establish what hedging is. Hedging is considered to be making an investment to reduce the risk of adverse price movements on an asset. One of the risks associated with hedging is the risk from change in currency in foreign currency transactions.
There are three exposures that companies hedge against relating to foreign currency transactions, these are transaction exposure, translation exposure and economic exposures.
Transaction exposure relates to the exposure created when the company has agreed to either receive payment through foreign currency, or to make payment in foreign currency. Simply put, if you were to purchase a product or service from a foreign country and agree to pay them in their currency, but you weren't required to pay until 30 days, there is a risk that the payment you have agreed to make now, will be higher in 30 days because of the exchange rate.
Translation exposure relates to translation the company's foreign subsidiaries from the foreign currency to the currency that the parent operates under. What the company risks is the subsidiaries loosing value because of the exchange rate.
Finally, economic exposure arises because the trading position of the company becomes at risk to adverse changes in the short and long term movements in the exchange rates.
What is essential to remember when deciding whether company's should hedge away this risk, is that the exchange rate, although slightly predictable, can swing either way and the company could be hedging away a gain.
The main argument against hedging is that shareholder's can hedge their own risk by creating an investment portfolio. Although I agree with this argument, to an extent, my opinion is why should a company bear unnecessary risk by not hedging, because the impact it will have on individual shareholder's won't be severe because they have undertaken their own hedging? It is my opinion, that the company should not bare the risk and that necessary hedging is important in success.
Although fuel hedging is not the same concept as hedging against exchange rate risk, the example I will introduce exemplifies my argument. The price of fuel has seriously affected the airline industry and Southwest Airlines has managed to successfully hedge against the risk from fuel prices. Since 1999, Southwest Airlines has managed to save around $3.5 billion. My argument is, because the price of fuel can rise and fall, Southwest Airlines may have missed out on some gains, but by hedging the amount they have saved outweighs the gains. In essence, surely avoiding losses is more important than taking advantage of gains? I suppose that is at the indiscretion of individuals as to what risk they are willing to take!
There are three exposures that companies hedge against relating to foreign currency transactions, these are transaction exposure, translation exposure and economic exposures.
Transaction exposure relates to the exposure created when the company has agreed to either receive payment through foreign currency, or to make payment in foreign currency. Simply put, if you were to purchase a product or service from a foreign country and agree to pay them in their currency, but you weren't required to pay until 30 days, there is a risk that the payment you have agreed to make now, will be higher in 30 days because of the exchange rate.
Translation exposure relates to translation the company's foreign subsidiaries from the foreign currency to the currency that the parent operates under. What the company risks is the subsidiaries loosing value because of the exchange rate.
Finally, economic exposure arises because the trading position of the company becomes at risk to adverse changes in the short and long term movements in the exchange rates.
What is essential to remember when deciding whether company's should hedge away this risk, is that the exchange rate, although slightly predictable, can swing either way and the company could be hedging away a gain.
The main argument against hedging is that shareholder's can hedge their own risk by creating an investment portfolio. Although I agree with this argument, to an extent, my opinion is why should a company bear unnecessary risk by not hedging, because the impact it will have on individual shareholder's won't be severe because they have undertaken their own hedging? It is my opinion, that the company should not bare the risk and that necessary hedging is important in success.
Although fuel hedging is not the same concept as hedging against exchange rate risk, the example I will introduce exemplifies my argument. The price of fuel has seriously affected the airline industry and Southwest Airlines has managed to successfully hedge against the risk from fuel prices. Since 1999, Southwest Airlines has managed to save around $3.5 billion. My argument is, because the price of fuel can rise and fall, Southwest Airlines may have missed out on some gains, but by hedging the amount they have saved outweighs the gains. In essence, surely avoiding losses is more important than taking advantage of gains? I suppose that is at the indiscretion of individuals as to what risk they are willing to take!
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