Part A 1. The dividend policy Ordinary dividends are defined as cash from the company’s profit distribution to shareholders (Garvey, G. T. and Swan, P. L. 1994). In other words, the dividend is the share of company profits for investors, to give for the investors a share of capital. Companies are able to distribute free cash flow by paying a dividend and trusts are able to distribute free cash flow by paying a distribution. Dividend policy refers to the decision by companies to pay out net profit or retained earning to shareholders as dividend or alternatively to reinvest those profits as retained earning (Dunstan, B 1992).
One of the biggest wish of shareholders is receiving high dividends. However, a high dividend rate is not really a sigh of successful business. An unreasonable high dividend policy will be considered as a “milking machine”, which will squeeze the capital that business needs to reinvest. 2. The importance of Dividend policy When a company generates free cash flow, it can retain all or part of this cash flow for future use or, alternatively, it can pay a dividend to its shareholders. The dividend policy decision is tied directly to the financing of a company (Walker, S. nd Partington, G 1999). There are three criterion include: the foundational concept, the managerial considerations and the design approach, that are needed to critically evaluate the importance of an effective dividend policy. a. The foundational concept Company may also elect to pay special dividends. This allows companies to pay additional one-off dividends to their shareholders. (Brown, P and Clarke, A 1993). Dividend decisions of firms are considered as a message, which can be dissected and evaluated the financial condition as well as business perations and management capability. This is reflected from the fact that a dividend decisions of firms the market can be evaluated positively or negatively by the rise or fall of stock prices. Reasonable dividend strategy not only helps companies obtain growth financing effectively but also improve the liquidity of shares, attracting new shareholders. Depending on the business operations and development stages of the businesses that the dividend is determined as appropriate.
For example, A enterprise which is in the technology sector are at the stage of development will tend to pay lower dividends, or even not pay dividends for years to focus on re-investment expansion; whereas , B enterprise has a maturity in the field of facilities and infrastructure service will generally pay dividends regularly and stability. While earnings are influenced by unpredictable developments in the economy and industry in which a company operated, dividends are set by directors, who usually like to pay a smooth and growing dividend stream.
An appropriate dividend policy will depend on the structure of the company’s share register as different shareholders may have varying dividend preferences (Balachandran, B. and Nguyen, T 2004): • Retail investors tend to value progressive dividend policies _ an increasing ordinary dividends on an absolute per share basic • Institutional investors generally recognize the capital theory of a proportional dividend policy _ ordinary dividends paid as a percentage of earnings
A progressive versus proportional dividend policy reflects the balance between paying increasing dividends to reward shareholders and retaining profits to pursue growth opportunities or other capital expenditure. b. The manager consideration There is no requirement that a company pay its shareholders any particular amount of dividend at any particular time. However, since shareholders are the residual claimants of the company’s cash flows, they do in a sense own the amounts of cash that the company produces net of all other contractual requirements.
Financial managers of a company must decide how much of its residual cash should be paid as dividends to shareholders. In terms of dividend policy, financial managers must decide if profits will earn higher returns for owners by being reinvested into the company as retained earnings or by being paid out as dividends. When determining the dividend policy, a company looks at its own mission statement and objectives to determine how much will be shared with stockholders. If the company values its shareholders significantly above everything else, it will try to give as much as possible to them in the form of dividends.
If the company uses more debt to finance operations, it may not put as much of a priority on shareholders so it can retain more earnings. When a company needs to expand and grow, it will require more money. If a company has already expanded significantly, it is not necessary too much of money, thus money can be distributed to the shareholders. Another factor that can play into the dividend policy is the amount of volatility involved in the company’s earnings. Companies that have a large amount of volatility are less likely to pay regular dividends than those that are stable.
Manager making dividend decision has three main considerations – Distribute full dividends that is return the complete cash asset of retained profit to enrich shareholders wealth through dividends – Partial dividends, it means holding back a portion of the retained profit; perhaps for company growth and liquidity, sustaining desirable gearing – No dividend means retaining the full sum of post-tax gain; perhaps for a mix of company needs such as investment, enhancing working capital efficiency, ensuring corporate liquidity and re-tuning company capital structure for an optimum gearing c. Design Approach . The traditional view Realistically, companies that pay constant dividends are somewhat rare, although they do exist. The more common approach is to calculate the value of a company’s free cash flows, and then subtract the book value of net debt to arrive at a value for equity. A more plausible assumption to make regarding the behavior of the dividends of a company is that they grow at a steady rate. The director of a company generally prefers paying dividends that grow steadily. An appropriate model in this section is developed for pricing equity securities under the constant growth assumption.
Consider the dividend stream: Pt = Do (1+g)/(r – g) = D1/(r-g) in that, grows perpetually at a rate g, where the first dividend is paid at the end of the first year and is equivalent to Do(1+g) There are two critical features of this formula that need to be understood in order to apply it correctly. First, the model dose not take into account any dividend that has just been paid or is about to be paid, for example D0 is the dividend at time 0. Second, the derivation of the model assume that the equity cost of capital must be greater than the dividend growth rate, for example r > g.
In fact, if this condition dose not holds, the value of the share is negative according to the model, which of course dose not makes any sense. ii. Viewpoint of Modigliani and Miller (MM’s model) Professor Merton Miller and Professor Franco Modigliani, from the University of Chicago and MIT, respectively, published a famous paper on the shareholder wealth effects of dividend policy in 1961. Their paper mathematically proved that dividend policy has no impact on shareholder wealth, given a number of assumptions.
The paper sets out what has become known as the dividend irrelevance’s proposition. M&M’s work should not be viewed as proving that dividend policy is irrelevant to shareholder wealth; rather it should be seen as setting out the conditions under which it is irrelevant. The main assumptions underlying the M&M dividend irrelevance proof are: – There are no cost of issuing shares – There are no costs of trading shares – All market participants, management and shareholders have the same information – There are no personal or corporate taxes
According to Merton Miller and Franco Modigliani (1961), in a perfect market (no taxes, no issuance costs, trading costs and information costs), dividend policy does not affect value of shareholder equity. The basic assumption of this perspective is that investment decisions of firms not affected by dividend policy. When the investment policy of the company is most important because it determines the future income of the company and therefore, it decides the value of the company. The income stream which is divided between dividends and how it retained earnings does not matter.
However, if we compare this view with the actual situation of the stock market, we can see the contradiction. The fact that the increase in dividends is usually considered as good information leads to an increase in stock price, and vice versa when companies reduce or not pay dividends again, the stock price will decline. iii. Legal context Most economists agree that in a world without taxes, and then investors will be indifferent to the receipt of dividends or capital gain. But in fact, income from dividends is taxed higher than capital gain income.
So the logic would be the conclusion that investors may prefer not to receive dividends. This will be reflected in stock prices. Other factors constant, the stock prices of companies paying dividends will lower the stock prices of companies to retain earnings for reinvestment. According to research by Black and Scholes (1974), the majority of U. S. companies spend between 40% and 50% of income to pay dividends. When the company decides to pay dividends, then it proves that the dividend brings some benefits to shareholders.
Benefits include: The payment of dividends to benefit the shareholders are in need of income and prevent them from having to sell stocks and brokerage charges; help shareholders assess the risks of the company, especially when the companies due to pay a high dividend to raise capital from outside. iv. Other viewpoints • Information asymmetry: It is reasonable to argue that the management of a company has more information relevant to assessing the company’s future prospects than the shareholders. Consequently, dividend policy may act as an information signal to investors.
According to research by Bhattachar (1979) and Miller and Rock (1985), the investors did not react to dividend policy, but with the information contained in dividend policy. Dividend policy may contain information and can be regarded as a signal of likely future development of the company. But this view is only meaningful when satisfying two conditions: First, investors value this information; secondly, the dividend is a signal about the prospects of the company and a credit reliable performance than other signals Agency theory: There are those who think that dividends also play a role in the problem of conflicts of interest between shareholders, managers and creditors. These are called agency considerations. The payment of cash dividends can be regarded as a shifting of control of these assets from managers to shareholders, the latter then having the option of whether or not to allow managers to regain operating control over such assets. This may constrain managers to behave more in the interests of shareholders. The clientele effect: The investors are classified into three groups of investors. The first group is those who prefer a dividend; the second group is indifferent to the dividend; and the third is who does not like dividends. The high-dividend stocks will attract people who like dividends, such as investors have held in the U. S. , because they only have 30% of taxable dividends received from another company, or attract individual investors with lower income tax rates.
In contrast the low-dividend stocks will attract people who do not like dividends, such as individual investors incur income tax. When companies select a certain dividend policy, the company will attract a certain group of investors. • Cost of distribution and indicator dilution of ownership: The payment of higher dividend rates also means that companies must raise capital from external capital as needed. Then the company must bear the cost of distribution and indicator dilution of ownership when issuing more shares.
These costs may make companies do not want to pay high dividends. 3. Managing the Implication. There are several considerations that factor in to a corporation’s decision as to whether to issue dividends. The corporation must make interest payments to creditors to remain solvent, but it has discretion in deciding whether to return profits to shareholders in the form of dividends. Interest payments are tax-deductible costs, but dividends are paid out of net income. Further, preferred stock carries rights to receive dividend payments prior to common stock equity.
Enhancing shareholder value is the mission of all publicly traded corporations. In terms of dividend policy, financial managers must decide if profits will earn higher returns for owners by being reinvested into the company as retained earnings or by being paid out as dividends. • Due-diligence: it is necessary for due-diligence to cover some important elements when evaluating the relevant of policy and its impact before implementing it. – Enhance satisfaction of shareholder in maximizing their wealth with the company, in order to get more and more their trust with the company Reasonably facilitate the source of capital such as towards minimizing cost of capital and wider choice of lenders – Support the opportunity to optimize the capital structure for efficient gearing – Ensure the adequacy of fund availability in investment appraisal of wider choices of positive NPV projects) – Promote the effectiveness and efficiency of Working Capital • Understanding the circumstances: Paying any dividends reduces the size of the shareholder’s fund retained in the firm which in turn affects the level of gearing.
It is need to be suggested a link between dividend policy and capital gearing – Investment opportunities in the future: Consider investment opportunities in the long term when deciding the rate of dividend will help the company have been active in finance and reduce costs by having to raise capital outside. – Risky in business: Because the dividend cut usually causes a negative impact on stock prices, companies must offer a dividend that they can maintain in the future. – Requirements of the shareholders: Dividend policy should be based on the requirements of shareholders.
If the shareholders are individuals who have high income tax and expect to receive capital gain dividend, the higher will have no meaning for them – Liquidity and ability to raise capital of the company: The volume of assets with high liquidity and ability to raise capital on financial markets as well as the determinants of the dividend of the company. The ability to raise capital on the market lower the more that companies want to retain earnings to reinvest rather than pay dividends to shareholders. Ability to lose control the company: If company managers are afraid of losing control of the company, they will be afraid to issue new shares. In this case, the retained earnings to service the investment needs, and thus maintain lower dividend rates, the policy is reasonable, especially when the debt on the company’s share capital stood at maximum Part B 1. Corporate Restructuring Businesses survive and develop through several stages with different steps of the historical vicissitudes.
At any stage of development that businesses also face risks from the external business environment and the weakness of the enterprise. Orientation must be placed in the context of current integration to create a competitive advantage, related to a change in thinking, perception, about how to manage and operate. Restructuring corporate means redesigned to lightweight, flexible and adapts to change of environment. Restructuring corporate concerned about the systematic and professional in their approach to work and coordinate work as well as executive work.
In terms of current integration, the restructuring requires companies to change management thinking, management reform, restructuring of business processes, based on which the model shape and structure in accordance with conditions and business-oriented enterprises. The arrangement, change comprehensively, according to standard procedures for businesses will be able to perform their jobs efficiently and sustainably, thereby creating a sustainable competitive advantage, improve position in the international arena. 2.
Corporate restructuring in term of Mergers and Takeover Trends in modern management separation of ownership and management, the essence of ownership is decisive in the election of the Board and thereby select the managers, and decision strategy , profit sharing plans and handling assets of company. A merger is the act of the company to form a new company bigger scale. Takeover is a company acquired another company, thereby commanding the business activities. Mergers/Takeover plays increasingly important role in the modern economy; information about mergers/takeover is the dominant information on the means of media in developed countries.
The total amount of money in the famous merger is really great. For example, acquisitions German company Mannesmann by British company Vodafone in 2000 is assessed at USD 183 billion. This contract is created from the largest companies listed on the London Stock Exchange, and is the 4th largest company in the world. This principle is particularly useful when the company fell on hard times due to competition or other market factors. Big companies will buy other companies to create a new company more competitive and reduce costs.
Companies after mergers/takeover will have the opportunity to expand the larger market share and achieve better business performance. Small companies are the subject of purchase is also available to buy other companies as this would be much better is bankrupt or is very difficult to exist in the market. An acquisition is considered a takeover or merger depends entirely on whether it is held in a friendly between two sides or coercion or another acquirer. On the other hand, ns also convey information to the outside as well as recognition by the board of directors, employees and shareholders of the company. . Reason for Takeover/Mergers There are countless reasons why a company chose to merge or be acquired by another company. For companies in highly competitive environments, the mergers/takeover can help them resist the larger companies. Thus the competition to promote mergers/takeover, and mergers/takeover makes the competition more than intense. The resonant is most important reason and the most amazing explanation to every merger and acquisition/Takeover. Resonance will allow efficient and value of new business after the merger is improved.
The benefits that businesses expect every mergers/takeover include: • Instead of competing forces: the merger between the companies which are competitors to reduce competition, increase business efficiency. • Improve efficiency: Through the mergers/takeover firms can enhance the economies of scale combined market share, reduce costs and additional integration of resources such as brand, information, technology, customer basic. • Scale up rapidly and dominate the market: The company is working efficiently often want to quickly increase the size to dominate the market not only their business but also jump into the industry are other potential. Reduce staff: The two merged system will reduce more jobs indirectly, for example, office work, finance, accounting or marketing. The job reduction is also required to increase labor productivity. This is also a good opportunity for businesses to dismiss the workplace inefficiency. • Equipped with new technology: To remain competitive, companies always need to position the peak of technical development and technology. Through the sale or merger, the company can leverage each other’s technology to create competitive advantage. Strengthening market share and reputation in the industry: One of the objectives of mergers/takeover integration is to expand new markets, revenue growth and earnings. Merger to allow for expansion of marketing channels and distribution systems. • Implementing the strategy to diversify and shift in the value chain: Many companies actively implement M & A strategy to realize the diversification of products or expand their markets. 4. Methods of Corporate Restructuring ( Mergers/takeover) Based on the structure of each business, there are many different forms of merger.
Here are some types are distinguished based on the relationship between the two companies merged to conduct: – Horizontal mergers: Occurs for two companies in direct competition and share the same product lines and markets. – Vertical Mergers: Taking place for businesses in the supply chain, for example, between a company with customers or suppliers of the company. – Merger market expansion: Occurs for two companies selling the same product but in different markets. – Merger of expanded product:
Occurs for two companies that sell different products which are related to each other in the same market. – Merger type group: two companies do not have the same business but want to diversify business operations have sectors. There are two forms of merger are distinguished based on how the financial structure. Each form has certain implications to companies and investors: – Merger of purchase: As the name expresses, this kind of merger occurs when one company bought another company. The purchases of the company are conducted in cash or through a financial tool. Merger integration: the form of merger, a brand new company is formed and both companies are consolidated under a new legal entity. Finance of the two companies will be consolidated in the new company. 5. The issue of pricing in mergers/takeover Typically, both parties in acquisitions or mergers are different assessments about the value of the company being purchased: the sellers tend to price your company at the highest level possible while the buyer will try to pay the lowest price in the possibility.
The following are some methods in order to pricing the value of company: – The ratio P / E: The buyer can compare the P / E average of the shares in order to determine a reasonable bid – The ratio of enterprise value of sales (EV / Sales): With this index, the buyer compares the index with other firms in the industry and will bid at a more than a number of revenue – Replacement Cost: In some cases, trading is based on considering the cost factor to establish a company from scratch than to buy a company that is available – Discounted cash flow method (DCF): This is an important tool in the evaluation of mergers and acquisitions. The purpose of the DCF is to determine the present value of the company based on estimated future cash flow.
Estimated cash flow which is calculated by the formula: Profit + depreciation – capital expenditures – change in capital flow , discounted to present value taking into account the weighted average of the company’s capital (WACC). Of course DCF has its limitations, but very few tools that can compete with this pricing method in terms of methodology. References list: • Garvey, G. T. and Swan, P. L. (1994), “The economics of corporate governance: Beyond the Marshallian firm”, Journal of Corporate Finance, vol. 1 • Dunstan, B. (1992), “ Understanding Finance with The Australian Financial Review”, Financial Review Library, Sydney • Knox, D. M. , Zima, P. and Brown, R. L (1999), “ Mathematics of Finance”, 2nd Edition, McGraw-Hill, Sydney • Lonergan, W (2003), “ The valuation of Business, Shares and Other Equity”, 4th Edition, Allen & Unwin, Sydney , NSW • O’Brien, J. nd Srivastava, S. (1995), “ Investments: A visual Approach”, SW college Publishing, USA • Copeland, T. E. and Weston, J. F (1992), “Financial Theory and Corporate Policy”, McGraw-Hill, California • Officer, R (1994), “The cost of capital under an imputation system of taxation”, Accounting and Finance, vol. 34 • Harris, R. and Marston, F (1992), “Estimating shareholders risk using analysts’ growth forecasts”, Financial Management, vol. 21 • Fama, E (1970), “Efficient capital markets”, Journal of Finance, vol. 46 • Miller, M. H. and Modigliani, F. (1961), “Dividend policy, growth and the evaluation of shares”, Journal of Business, vol. 34 • Brown, P. nd Clarke, A (1993), “The ex-dividend day behavior of Australian share prices before and after dividend imputation”, Australian Journal of Management, Vol. 18 • Shevlin, T (1982), “ Australian corporate dividend policy: Empirical evidence”, Accounting and Finance • Walker, S. and Partington, G (1999), “The value of dividends: Evidence from cum-dividend trading in the ex-dividend period”, Accounting and Finance, 39 • Balachandran, B. and Nguyen, T (2004), “Signaling power of special dividends in an imputation environment”, Accounting and Finance, 44 • Partington, G (1984), “Dividend policy and target payout rations”, Accounting and Finance, vol. 3 • Lintner, J (1956), “Distribution of incomes of corporations among dividends, retained earnings, and taxes”, American Economic Review, Vol. 46