Blog 10: What kind of dividend policy is the best?

If the investments decision is not attractive to the investor, investor would focus on the other decision – dividend policy. “Dividend Policy is the determination of the proportion of profits paid out to shareholders.” (Arnold ,2008) It is important that firms should have a right level of dividend to the shareholder every time. For example, firms may pay dividends at higher level, same level, lower level or not pay dividends.

Managers have the responsibility to formulate the best dividend policy for both side of corporate and shareholder. Dividend is used to protect the creditors that preventing the shareholders to remove funds from the firm. Therefore, even the firms have loss this year, they may still pay dividends in order to satisfy shareholder to remain investment to the firms. According to Porterfield (1965), dividend policy should aim to maximize shareholders wealth which Porterfield point out that dividend payment only under the situation that new share price is higher than previous share price.

However, Modigliani & Millar (M&M) (1961) argue that if a few assumptions can be made, dividend policy is irrelevant to share price. The share prices are determined by future earning potential, not dividends paid now. Therefore, M&M point out that the share value is determined by investment policy, not by the amount of earning distributed. It means that dividend is only a residual after all the positive net present value (NPV) project investment and earnings are left over. (Arnold, 2008) It is because the market value would rise to reflect future increasing returns due to all positive NPV project that maximize share price of the firms.

Nevertheless, Linter (1956) and Gordon (1959) argue that dividend policy is relevant to the share value. They claim that investors prefer to receive dividend rather than invest the same amount of dividend into the uncertain investments. Investors do not access internal information. Therefore, dividend is the only way to let them know the performance of firms well or not. Arnold (2008) argues that shareholders are interested in whether the firms pay dividends or capital gains. They need regular income such as retired people prefer a high and steady income likes pension funds.

Commerzbank in Frankfurt plans to raise capital to $15.6 billion for repaying a major chunk of state on this Wednesday. Commerzbank shareholders can join mandatory convertible bond in a book-building exercise. This strategy will phase out silent participations as eligible core capital. Therefore, it will reduce annual coupon payments of 9% the bank has to make on the silent participations if it makes a profit under German accounting standards. It will increase when it pays a dividend to shareholder. However, SoFFin from the German Financial Market will enhance corporate actions to maintain its minority in 25% of profit.(The Wall Street Journal, 2011)

By M&M theory, Commerzbank’s policy is profitable strategy for those shareholders, Commerzbank try to reduce annual coupon payments to maximize market price of banks. As the result, shareholders can gain since there is an increase of share price. However, in my opinion, Commerzbanks should not rush to raise capital. Although this strategy would significantly improve the capital structure of banks that make a profit under German accounting standards, there are still a lot of risk factors about it such as the financial market is uncertain about Portugal bailout. Thus, banks cannot predict the consequences of raise capital. Also, as the argument by Linter(1956) and Gordon(1959), in this unpredictable environment, shareholders would prefer to receive dividend rather than Commerzbank use the same amount of money to raise capital.

Those arguments of dividend policy have existed for decades. Firms might choose rather “M&M policy” or “Linter and Gordon policy” or others. It would have different results at the end. However, as I have mentioned in last week blog post, in the real world, there would not have those assumption by M&M, like no taxes, no transaction costs or borrow and lend at the same interest rate. It is because it would not happen. Otherwise, the set up of government and stock market exchange would be useless since we can also assume there would not have any fraud or tax evasion in this financial world to establish M&M assumption.

Reference:

Arnold, G. (2008) Corporate Financial Management. 4^th edn. Harlow: Financial Times Prentice Hall

Blog 9: Capital Structure affect firm's decision

The main task for the managers is generating the shareholder value. There are many methods to maximize shareholders' wealth, one of the method is mixing debt and equity. Firms may increase gearing level to decrease the weighted average cost of capital (WACC). However, as we know, gearing is a relationship between debt and equity. Therefore, increasing gearing level that means increase the debt level, firms have to pay a large amount of dividends interest for those debt. As the result, financial crisis may occur. Thus, firms have to control the gearing level to “just in level” which not too high that generate risk to shareholder or too low that break the opportunity of generate shareholder value. Therefore, a better method is optimal capital structure by mixing debt to equity.

However, a description of gearing level in 1958 by Modigliani & Millar (Arnold, 2008, p.793) argues that there is no impact on the WACC to shareholder wealth and no optimal structure exists. But his theory is assuming that there is no taxation and no costs of financial distress and liquidation. Even the theory is correct, can it apply to this real world business? In my opinion, it can’t.

The share price of Bank of Ireland increased 41% to prevent the government take the majority stake of the bank. However, a test which was found by Irish banking system stated that those banks need £21.2bn to survive the financial crisis. Bank of Ireland tries their best to meet the capital requirements from Irish banking system. (BBC, 2011)

They may do it by debt management which increases the debt to reduce government Intervention. However, as mentioned above, these would cause financial crisis.

Some analysts suggest another method that Bank of Ireland might solve this problem by restructuring. It is because the cost of restructure is paid by taxpayer. (BBC, 2011) However, if relate to the theory of Modigliani & Millar, assuming there is no taxation. Who are going to pay for these? Ultimately, Bank of Ireland has to pay for it.

If Bank of Ireland raises funds by other countries banks, it may cause credit crunch. Thus, it means that Bank of Ireland is difficult to raise funds by those methods to finance business.

In this situation, Bank of Ireland has to make decision how to raise money that least harm to the firms. As mentioned above, Modigliani & Millar theory can’t apply to the real world, I think the most suitable method is to restructure the business to prevent government take the majority stake of Bank of Ireland that reduce the shareholder’s wealth.

Reference:

Arnold, G. (2008) Corporate Financial Management. 4^th edn. Harlow: Financial Times Prentice Hall

http://www.bbc.co.uk/news/business-12932334

Blog 8: Investment appraisal tools

This week we will discuss the nature of risk in an international business context. Firstly, we should identify what is risk. According to Bessis (2010), “Risk is not identical to uncertainty. Uncertainty refers to the randomness of outcomes. Risk refers to the adverse effect on wealth that such outcomes have. Risk exists only when uncertainty can have a potential adverse effect, which is a possibility of loss.”(p. 26)

To reduce investment risk, there are risk assessment and advanced investment appraisal tools to assess the risk to let manager know the investment is worth or not.

Before making an investment, managers have to estimate the investment project. Investment analysis tools may help manager to evaluate the risk that associate with the project. There are several investment analysis tools for manager to estimate, such as payback period, accounting rate of return. However, these tools ignore the timing of cash flows. Therefore, managers have to take the time value of money into account to measure the risk and inflation that achieve the most effective assessment of the investment project. They may use net present value (NPV) or internal rate of return (IRR) methods to calculate the discount of cash flow. However, compare NPV with IRR. The time value of money measured by NPV that may absolute calculate the amounts of wealth change while IRR cannot. For example, there are two projects, Project A is 5 years project and Project B is 7 years project. NPV can give manager the figures for both projects. However, IRR cannot give the figures for both project which make manager cannot compare the project whether is worth to do or not easily. Therefore, even both of them are time-adjusted measures of profitability, most of academics prefer NPV technique than IRR. In fact, large organizations would use three or four methods for project appraisal. It is because they don’t rely on only one project appraisal for evaluation.  (Arnold, 2008)

However, it is a bit difficult when using the NPV method, which comes up with estimate cash flows and cost of capital. It is difficult to determine cash flows and cost of capital. The input of information is important for decision because good decisions are born with good information. Therefore, mathematical technique is only one of the elements for investment decision. There are other factors that affect the decision such as strategy, social context which have mentioned in previous blog post.

How the corporate apply this theory in the real world? Dolce & Gabbana (D&G) plans for 15 new stores across China in an effort to boost business in the world’s fastest-growing luxury-goods market. (The wall street journal, 2011) It is an enormous project for D&G, why D&G would launch this strategy?

I think there are several factors that push D&G forward to launch this strategy. Firstly, Research group CLSA Asia-Pacific Markets estimate that the sale of luxury goods will reach $101 billion in 2020. Secondly, Sales in China and other parts of Asia account for 16% of D&G global sales (nearly $1.46 billion) last year. The sales jumped up 26% from a year earlier. Lastly, China would influence the future of design and the fashion industry.

However, there are some problems for these factors. Is the figure from CLSA research group calculated by investment appraisal? It is huge difference if $101billion is cash flow value rather than net present value. Also, how can D&G sure that the estimate profit from China can cover the development cost of this enormous project? Just based on the previous sales figure? 

In my opinion, even there are many other factors that affect D&G’s decision, such as China would influence the future of design and fashion industry and D&G have to follow the competitor (Which I have mentioned in previous blog post- Pros and Cons of Foreign Direct Investment), but investment appraisal tools are also important. Therefore, it is better for D&G consider the project with the investment appraisal tools that may make the best decision to bring benefit for the shareholder. 

Reference:

Arnold, G. (2008) Corporate Financial Management. 4^th edn. Harlow: Financial Times Prentice Hall

Bessis, J. (2010) Risk Management in Banking. 3^rd edn. Chichester : Wiley & Sons Ltd

Blog 7: The impact of the earthquake in Japan

Last week, there is Earthquake in The world's third large economy - Japan. Earthquake not only caused serious injury or death, family breaks, it also brings a serious hit to the Japan economy and the stock market.
It occur global market volatility in the short term. It increases global economic instability. And based on the problems caused by nuclear power plant that result of stimulates the price of oil rising and raise energy prices problems.

Share price in some best known multinational companies and country banks such as Sony, Toyota dropped sharply.

“Sony fell 9.1%, Nissan dropped 9.5%, Toyota was 7% lower, the banking group Mizuho was 10.5% down. Pretty much all automotive manufacturing has been suspended. Sony has closed six component plants.” (Peston, 2011)
This loss the confidence of investors because fear of the uncertainty market. As the result, they sell their share that affects the price of Japanese government bonds fell.

Earthquake also forces the Japan insurance industry to sell overseas assets to pay a huge amount of claims. The government must provide financial support to the regions which affected by earthquake. Also, it would inject a huge amount of fund to rescue the market. Reconstruction cost plus insurance payments may carry a huge loss for government and consequence as raise taxes or expand the Government deficit.

The bank of Japan keeps its cost at the lowest price and maintains its integrity. It is because the banking system is the most important of the economic infrastructure.

Bank of Japan announced that its economy will inject £165bn of the funds to repair economy. (Business concern, 2011) It is almost five times of funds compare with Lehman brother collapse in 2008.

On 16 March, The bank of Japan injects £27bn to shore up the financial markets.

The injection comes after the central bank announced a cash input of 23tn yen ($284bn) on Monday and Tuesday. (BBC, 2011)

It is the evidence shows that the government invests substantial capital to the banking sector is trying to enhances investor confidence and maintain the liquidity in Japanese market that prevent the banking crises.

However, the earthquake would certainly exacerbate hit in Japan economy. It is because the government’s financing cost would rise and the government have to reconstruction Japan finance that increase the risk of default.

Also, the Japanese government’s credit rating has recently been downgraded (AA-), Moody’s (Credit rating agency) point out that disaster bring out the potential of financial crisis. It means that investors fear about the ability of Japan to repay its debts. It shows that Japanese government is now considered as risky. 

In my opinion, the reconstruction process should not bring out by Japan only; the global has to unite in to handle this sudden disaster. It is because country’s economy is inter-related. Otherwise, domino effect would not appear in 2008 of financial tsunami.

I totally agree with what Peter Westaway of Nomura had said as show below:

“He expects the rating agencies - Moody's, Fitch and S&P - to "cut Japan some slack" for "humanitarian reasons". Or to put it another way, as and when the Japanese government deficit grows because of the costs of reconstruction, they will not downgrade Japan's credit rating - unless (I suppose) it became clear that the Japanese government had abandoned all hope and intention of restoring the health of the public finances. Or to put it another way again, the credit rating agencies would not wish to be seen to be triggering a fiscal crisis, as the aftershock of a national tragedy.” (Peston, 2011)

Credit rating agency may downgrade Japan’s credit rating if only focus on investment grade, but they didn’t do that. I think it is because of “humanitarian reasons”. They don’t want to create another panic after Earthquake anymore.

Resources:

http://www.bbc.co.uk/blogs/thereporters/robertpeston/2011/03/how_will_japan_finance_its_rec.html

http://businessconcern.net/bank-of-japan-injects-165bn-in-effort-to-repair-economy.html

http://www.bbc.co.uk/news/business-12755607

Blog 6: Merger and Acquisition Activity

Last week, we talk about advantage and disadvantage FDI. Actually, FDI has divided into two activities, they are Greedfield investment and international merger and acquisition (M&A) activity. Greenfield investment is the companies enter to new market by buying the land, building the factory, or doing it by joint venture. M&A activity is totally different with Greedfield investment. It is two organizations agree to join together and pool their assets into a new business entity called merger, and joining of two unequal partners by agreed acquisition or hostile acquisition called acquisition.

In my opinion, if company want to enter the new market quickly. M&A is better choice for company to enter the new market. For example, Oil companies don’t have to build up power plant for 4-5years. Also, M&A may let both host and invest side to apply superior managerial skills or obtain unique technical capabilities by sharing their knowledge.

However, M&A activity would link to economic uncertainly that is political risk. We can see that from 2000 to 2002, the US and World recession fear reduce corporation activity. As the result, M&A activity would slowdown because of the company focus on its own core business or decline in market confidence. Therefore, M&A activity would be affected by economic stability.

M&A activity is seeking for sector concentration which means sector have to concentrate in same industries to improve concentration. Why? We know that there are petrodollar recycling between oil industry and bank. Why doesn’t company diversify itself for example oil industry acquires Bank? It is because it will use large resource (capital) to acquire bank that affect shareholder maximization and create monopoly problem in market.  Therefore, M&A activity is seeking for synergy that resource available to the merged businesses which can be more effectively exploited.

However, it is only the theory of M&A from the lecture, how about the real world? Even industry try to acquire same industry, it would still create monopoly problem in the market. Also, there are regulation from the government and pressure from the public while the corporation executes M&A activity. Therefore, the corporation has to face those problems that would not mention from the book.

Let’s look at hot topic on The News Corporation bid BSkyB. News Corporation plans to bid BSkyB for take over the rest of 61% of BSkyB from June last year. News Corporation offered 700p a share for BSkyB, valuing the company at about £12bn. Sky rejected the offer in June. (BBC, 2010)

The problem has come out. It always creates controversy on the media ownership.

“Sky's competitors (the BBC, BT ) complained the move could have serious and far-reaching consequences for media plurality". (BBC, 2011)

Which mean if the News Corporation bid BSkyB successfully, it would bring too much power to News Corporation (which owns the Sun, the News of the World and the Times and the Sunday Times) which may create monopoly problem in the media industry. That’s why media regulator Ofcom has to look at the potential impact of the deal on media plurality. It lets public concern about the independence of Sky News after News Corporation post acquisition that dominance of the media landscape.

Therefore, on 3^rd of March, Rupert Murdoch (CEO of News Corporation) has offered to dispose most of Sky News Channel to allay concerns about they have too much power in media industry. Also, News Corporation’s announced that the board of Sky News would have a non-executive, independent chairman and a majority of non-executive, independent directors. (BBC, 2011)

The News Corporation would want to complete the takeover at a price as fast as possible(700p at first bid) because it is a risk that the value of BSkyB could go up since there would be other competitors who want to bid BSkyB too. Just like the example we learnt in London Stock Market bided by Deutsche from 2004 to 2005. And NASDAWQ also launched a bid that would increase the share price of LSE.
The government approve for News Corporation bid to take over BSkyB on 3^rd of March. However, the share price has risen up to about 850p when government approved News Corporation to bid BSkyB.

It is a huge change to the UK media industry. It is because the merge of News Corporation and BSkyB would reduces revenues of all rivals. Also, the share price of BSkyB is now above 800p, So News Corporation have to raise its offer that mean about £2bn extra cost for takeover BSkyB.

Where does the cost (£2bn extra cost for takeover BSkyB) back from? It may back from reducing the cost of operation; it may back from generating more profit such as increase the charge for the channel. But as we know, it would mostly pass back to the public finally.

Also, there must generate more profit after News Corporation takeover BSkyB, and News Corporation would reinvest the money to its own company for improving digital technology to provide high definition TV for customer. It means that it would increase the competitive with other media organizations. And News Corporation must use that unique technology in other countries to generate profit. As the result, News Corporation might invest in other countries for more profit.

Are this M&A activity beneficial to UK’s media industry? It would depend on the News Corporation long term strategy. However, we might predict the answer by core concept - Maximization Shareholder Wealth.

After reading the news of The News Corporation bid to take over BSkyB. The process of M&A activity is not only seeking for synergy anymore. There are some ethical problems due to the M&A activity and company have to solve it.

Will the company monopoly market because of too much power? Thus, public have fewer options? Will public therefore suffer from it?

Blog 5: Pros and Cons of Foreign Direct Investment

I am going to talk about advantage and disadvantage of foreign direct investment (FDI).

Appear of FDI has increased international trade in global. It dissolves capital controls which mean there are no restrict of taking in or out of money anymore. Also, FDI grows substantially to support multinational business in other countries. It impacts Transnational Companies (TNC) which becomes major role in international production. As the result, the economy of world becomes more interdependent to create greater integration of financial market.

The inflow of FDI keeps increasing during recent years. FDI increase mainly in three groups of economies, they are developed countries, developing countries and transition economies of South- East Europe. Vast majority of FDI from developed country to developed country. It is because European Union is the largest host region within the developed country group that attracts almost two thirds of total FDI inflows. Also, the United States keeps its position as the largest FDI recipient country. (WIR, 2008) However, the growth of recession in US and uncertainty economic might lead investors to have cautious attitude. Therefore, investors may think about invest in developing countries. The best example is China.

Developing countries include Egypt, Nigeria, Morocco and South Africa. But China and Hong Kong still are the two largest FDI destinations in Asia. We might think about why FDI in China and Hong Kong? It is because it is risky for FDI in poor countries due to poor market strength and political uncertainty which are economic and political risk. Also, the quality of infrastructure in China was better than other countries. They have adequate roads, airports, power and world class network for FDI. The most attractive reason is that they provide low cost for labour, low tax rates and rich natural resources.

Developing countries encourage FDI because investor might obtain overseas resources, increase access to return markets and increase local capital markets. They attract FDI by resource transfer such as capital, technology, management skills. On the other hand, FDI provide employment opportunities to the developing countries. An example is the relationship between Apple and Foxconn. Foxconn, the world’s largest electronics manufactures which employs 1 million people in China. As the labour cost and material are low cost in China. Therefore, Apple chooses China to produce its product rather than exporting domestic production. Thus, Foxconn is licensed to manufacture apple product and therefore Apple is Foxconn’s biggest customer. Apple provides a lot of employment opportunity in China as there are large amount of parts and complicated production processes are required to make consumer electronic products. For Apple, it has to transfer its technology to Foxconn for them to make Apple’s products.

Also, Foxconn has attracted more than 20 of smaller supplier facilities to establish of new Foxconn. Analysts estimate that more than 100,000 of Foxconn’s 800,000 workers in China are working on Apple products. (Financial Times) Apple works its plants in Shanghai and Shenzhen, near Hong Kong where labour costs are outpacing the rest of the country. As we know, Apple announced to launch iPad 2 in this few days, due to the increasing demand of Apple’s product from the public, the employment in Foxconn should be obviously increased.

However, FDI flows have been mixed. At the firm level, companies have to transfer their product knowledge, technology, management skills and the knowledge of marketing as well as through their core product to the joint venture With committing product knowledge and technology to other companies, this may lead to direct competitors occurs. An example is Schwinn and Giaant, after Schwinn transfer intellectual knowledge (technology how to make the bike, management skill, cost control) to Giant. Giant make cheaper bikes than Schwinn and then enters into business itself.

Also, the company may lose control of product quality because they cannot supervise the produce process directly. Thus, it may ruin reputation of their brand.

And following competitors would appear, some corporation moves their business overseas to follow its domestic competitors in oligopoly structure markets and reduce the number of competitors.

In conclusion, companies may choose FDI due to the advantage as mentioned above. However, they still have to consider those problems would occur in FDI to have a win-win situation for both local and oversea companies.

Blog 4: Taxation

Taxation is not a voluntary payment or donation. It is a toll which is enforced contribution imposed by government. It is a non-penal, but compulsory transfer of resources from the private to the public sector (Wikipedia). Therefore, international company plans the strategy which will minimize the overall worldwide tax burden with most tax efficient position.

The most direct method for company to minimize the tax is keeping its operational base in low tax rate country. There are many countries tax rate are lower than UK, such as Philadelphia with 10% corporation tax, Cayman Islands with only 0% corporation tax. However, back to the discussion during the lecture, tax minimization strategy would have benefits for both the shareholder and the customer. Nevertheless, there would also generate loser. This discussion will leave to the last conclusion.

In my viewpoint, taxes are justified as it is necessary and beneficial to society because it reduces economic inequality which “the rich get richer and the poor get poorer” in a society. Let’s look at hot topic on Barclays paid ₤113m in corporation tax to the UK in 2009 which only 2.4% of its ₤4.6bn global annual profit. As we can see that the day after the news, tax-avoidance activists have targeted Barclays Bank. It is because bank has serious responsibilities as a corporate citizen. We need a strong banking system to support the economy growth for the society.

As we know long and short term cashflow may impact tax bill. Therefore, these figures cause the debate about excessive profits and bonuses in an industry underpinned by taxpayers’ money. Barclays therefore have commitment to the Treasury in Project Merlin that it would reduce the total paid out in bonuses. And result the banks decrease the bonuses compare with this year than last year.

In 2010, the total group revenue of Barclays is ₤31.44bn. However, there is also rising salary for staff which rose costs by 20% to ₤11.9bn, which ₤3,5bn was paid in bonuses. It is still a huge amount that affects the profit before tax. Therefore, Barclays has reported pre-tax profits of ₤6.07bn for 2010. Even Barclays paid over ₤2.8bn in taxes in the UK in this year. The bank still enjoying a better financial climate with only public opprobrium over bonuses remains unchanged.

What we need is ‘Parallel universe’, taxpayer subsidy for Barclays Capital and Barcap being able to borrow relatively cheaper which make profit at the end. However, Barclays had paid themselves (chief executive, shareholder, staff) with high salaries and bonuses. As the result, the taxes paid would be in a low amount. Let’s back to the discussion, don’t you think that the loser would be the taxpayer!?



Reference: 
Tax - Wikipedia, the free encyclopedia. Available at: http://en.wikipedia.org/wiki/Tax (Accessed: 24 Februrary 2011)