Question

Select your own firm or any firm that you are familiar with. Discuss the factors which have an influence on shareholders’ wealth. Identify managerial actions taken by the firm which are design to influence shareholder wealth.

Answer 1

Shareholders expect a consistant dividend policy. Bare in mind that paying dividends implies the firm has relatively limited growth opportunities.

At a bare minimum there is an expectation that the dividend will be held constant in either nominal or real terms. The firm may also be targetting a static dividend payout ratio (e.g. give back 40% of our annual earning to the shareholders).

Dividend Signalling theory implies that dividend policy changes are indicative of the firm’s health - after all companies are always going to try to paint themselves in the best light. While dividends are at the discretion of management, cutting a dividend is only done in quite dire circumstances - the signal from doing so generally has an adverse effect on the share price.

So, a non-exhaustive list of factors:

-A company’s past dividend policy

-The company’s trend in earnings and financial health

-Macro-economic risks - e.g. changing interest rates

These are often partially reflected in the share price prior to the dividend announcement with any surprises (difference between actual & expectation) being quickly accounted for.

Managerial actions taken by the firm to influence shareholder wealth -

1. Management’s decisions can be very affective the firm’s value.

2. Managers can increase the value of a firm by making decision that :

-i. Increase the level of expected future cash flows (CFs)

ii. Generate the expected (CFs) sooner (The timing of CFs)

iii. Increase the certainty of the expected CFs. (riskiness of Cfs)

3. Decisions about expected CFs include :

a. Capital structure decisions : how much and what type of debt and equity should be used to finance the firm?

b. Capital budgeting decisions : what type of assets should be purchased to help generate future CFs?

C. Dividend Policy decisions: How much of current earnings to pay out as dividends rather than to retain for reinvestment in the firm

4. Given external factors and constraints such as ; the legal constraints, level of economic activity, tax laws and stock market conditions, management makes a set of long-run strategic policy decisions that chart a future course for the firm.