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.
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