Dividend policy

According to realised news from China’s stock regulatory body (2012), companies who has not paid dividend for 5 years will be forced to quit stock market. Because these companies have not given investors a value return expectation.

Dividend decision is the major corporate long term financial decision. And management can affect the shareholder wealth through the dividend decision. But dividend decision is least analyzed in financial decision making. As stated by Black(1976), dividend policy is the ‘Dividend Puzzle’. The complications come from the relativeness to both the investment and financing decisions. Therefore, it is difficult to investigate the dividend policy in isolations.

There are two problems in dividend decision. Does the pattern of dividend cash flow affect the shareholder value? If it does, which particular patterns of dividend cash flow would maximize the shareholder value.

The valuation model of equity depends on the present value of expected future dividend cash flow. Therefore, dividend decision is the determinant of equity value. But is it the pattern of the dividend cash flow or the magnitude of the dividend that affects the value of expected flow? This is needed to further investigate.

In fact it is still ambiguous whether dividend policy can affect shareholders’ worth. Some empirical evidence tends to suggest dividend decision is important, and the taxation on dividends should be taken into account. Besides, given the imperfection of capital market dividend decision should be with cautions. A company to maximize shareholder value may keep a constant dividend cash flow which can allow investors to judge their desirability and have clear investment goals.

Capital structure and shareholder wealth.

The capital structure includes two types. One consists entirely of equity capital and the other is mixed capital structure where debt and capital are held in proportions. Where a capital structure is mixed with debt and equity capital, the WACC is the discounted rate which should be used for investment appraisal. In other words, a company’s WACC should be used as a NPV discount rate. Like the company Peacocks, a clothing retail store, has gone into reconstructing its capital structure with £240m debts.

The basis for that is the assumption that a company intends to maintain capital structure. It implies the capital structure of individual projects is purely a function of chance circumstances. Sometimes it is convenient to raise debt and sometimes equity. And a project should not be accepted if the rate of return is lower than WACC.

The WACC implies the concept of ‘pool of funds’, which means the appraisal, should not be sensible to particular source of investment cash. One cash flow enters the company means inflow to the general pool and cash outflows means funds are drawn out of the pool. The cost of using the whole pool funds is the WACC. Therefore, on the assumption that a company’s capital structure remain constant in a long run, it is WACC that measures the hurdle rate for a project. The cost of individual debt or the required rate of return for equity is not for designating a minimum acceptable return.

It should be noted that WACC is not perfect for investment appraisal. It is based on assumption that may not feasible in practice.

Social Responsible Investment

SRI is a new fashion for investors. In SRI non-financial factors are the basis for considering the profit. It is an ethical conviction for investors in choosing their investing position. According to Bloomberg News, the SRI fund increased by 20% in 2011. It indicate SRI is becoming the new fashion for investors.

The SRI funds have relatively higher initial charges, but since they are quite restrictive about the companies they invested in, they have performed relatively poorer than other types of funds. Another thing is that SRI directly involving in banking industry is a conflict of interest. Because cutting out firms with unfair or unsafe labour and poor environmental records will screen out vast firms banks invest in. there is no guarantee that banking system will do SRI investment without interest conflict.

And how well the SRI can hedge the financial crisis? The SRI invests in companies with restrictive option and profitability is not primary concern of the investment so that SRI cannot perform well compared to other investments. Thus, to what extent can we expect SRI to outperform when the market going down?

In my opinion SRI is a controversial term itself. Social and responsible standard is too restrictive to diversify the portfolio and outperform the market. It is difficult to do both socially responsible and profitable based on narrow investment choice. From a practical prospect, how can you ensure the managers of so-call SRI funds to give up the investment opportunity just because it is not socially responsible, especially when they have done time-consuming and costly quantitative and qualitative analysis? And will the SRI bring about good profitability when the investment choice is so restrictive and narrow and portfolio diversification is so difficult to do?

Why SRI is a fashion when it is nonsense obviously? To answer this question is beyond the financial scope. Like the theory of Global warming promoted by political organizations rather than meteorologist, SRI is a political issue rather than financial one. And also like so-called global warming, SRI is just a point created by politicians from where to expand and diffuse their influence in economy. SRI is an investment? Yes, but just for politicians, not us.

The shareholder wealth and the financial crisis

It is self-evident that financial crisis damages shareholder value severely and the depreciation of shareholder value is the result of financial crisis. But is the relationship between shareholder value and financial crisis that simple? One opinion is that the over emphasis of shareholder value is a catalyst of financial crisis.

In the case of JP Morgan, as reported by BBC news it also encountered credit crunch and shareholder value loss like any other finance companies in the crisis of 2009. Last Friday it suffered a loss of 20 million dollars in derivative business. The reason for JP Morgan involved in the loss is that the managers of JP Morgan invested lots of money in high risk derivative trading. But if looking insight the investment, it will be found the high-risk investment was encouraged by the board, the representation of the shareholders. In order to make more profit and create more shareholder value, the manager of JP Morgan chose to invest in high risk derivative trading. The purchase of shareholder value has served as a catalyst of high risk speculation. It seems that emphasis of creating shareholder value leads to misbehavior in the financial crisis and harms the shareholder value at last.

M&A and shareholder value

According to Angwing (2007), the M&A during 1996-2011 increased by more than $23.4 trillion. The scale of M&A is getting greater and becoming the major way of expanding business nowadays. The argument is raised up along with the rapid growth whether the M&A can create shareholder value. In the case study of Time Wanner and AOL the shareholder value is harmed by the M&A deal. At first the shareholder price was leveled up to $334.75 by the M&A deal, but one year later the loss from the M&A deal was up to $98 billion, which accounted for 97%of shareholder value.

Another case is Lenovo and PC business of IBM in 2005. The M&A deal helped Lenovo to expand its business overseas. The M&A deal made Lenovo the third greatest PC manufacturer in the world. But Lenovo did not stop the continuous loss from the PC business and the loss in 2006 was up to $21million loss. The overseas market share also was harmed by the M&A deal.

Overall 80% of M&A deal turned out to be profit loss 3years later. The M&A is quite a risky deal, but why still so many companies go to M&A every year? Actually, M&A is a means to build up controlling power in market for companies. Via M&A companies can become more influential in the market and this gives companies a power to affect the market price and seek a monopolistic position in market. It generates the high expectation for shareholder value that a monopolistic position will create more values. In the short term the M&A harms the shareholder value. But if the M&A deal can bring about an influential power even a monopolistic position for the companies, the M&A is still beneficial for shareholder value in long term.

FDI in India

The Indian government revealed that FDI from Pakistan was allowed. It is a signal for growing relationship between two countries.

The decision may not cause an immediate increase of FDI from Pakistan, but it does show that the two countries are going to a new level of trade and economic development. It is part of the trade normalization process. The Commerce, Industry and Textiles minister of India Anand Sharma commenced that procedure making is underway and will come out soon. As relationsip is growing warm, the opening up in investment will cut down the illegal trade by estimated 10 billion.

Governments hope the opening up in investment will bring about greater confidence in bilateral relationship. Economic development can solid the base for further trust as the economic tie between countries can keep close corporation.

The banks are keen to open new branches to expanse their own business. The progress of allowing banking services is going forward. New discussion has been initiated and a plan for setting up India-Pakistan council for better developing FDI is on progress.

Besides, the FDI in retail chain is argued in public. The FDI in India decreased for recent years. In 2011 the investment declined by $14bn. Besides, the Indian retail sector is going through a messy situation. The low efficiency and slumping growth rate force the government to take reformation in this sector. The FDI boost in the sector can help change the situation and bring more employ opportunity.

But the reformation will harm the small vendors in the business. Overseas companies will compete over the vendors and the small shops will have to close down and many people will lose their jobs. Also the local farmers is at the stake as the overseas companies will press down the price and squeeze the profit for framers. But it is good news for the customers as they will enjoy the premium service provided by overseas vendors.

Overall, FDI growth in India is a good sign for this developing countries. The capital inflows with FDI can help the countries boost their economy and create more jobs. Capital and jobs always are good element for developing economy. The FDI in retail sectors should be encouraged. Except for IT industries, other business industries in India are going through a slump developing. The FDI in these industries can change the low efficiency and messy management situation. It is going to have cost. The traditional management and developing pattern will be inevitably changed. Small vendors and local suppliers will harm. But the cost is worth in term of the benefit brought about.

If the FDI from neighbor country which has disputes in relationship, the FDI is not just good for the economy but also for the political stability in the region. FDI from Pakistan will enhance the cooporation between countries and solid the base for peace. The meaning of FDI is further than economic developing.

Bank of America dumps $75 Trillion in derivatives

According to Bloomberg reports, the Bank of America has transferred about $22 trillion worth of derivative obligations to the FDIC insured deposit division. Besides, the FDIC insured unit was already filled with $53 trillion of obligations, making a total derivative worth of $75trillion.

Derivatives are used to hedge financial risk from time to time, but mostly for speculation. The speculation is betting on stocks, bonds, mortgages, commodities and financial indices. Banks like Bank of America issue derivatives which are highly profitable to issuers and generate big bonus to executives who manage them when the derivatives are not triggered. And when the derivatives are trigged the obligation falls upon the issuer entity rather than executives. As for Bank of America, by putting the derivatives in insured retail banks and the insured retail division, the obligations falls upon taxpayers and savers. The value of derivatives is so large that the United States has to pay off the obligation by dollar depreciation if the derivatives are triggered.

The derivatives betting on the default of mortgages are the catalyst in the global financial crisis in 2008, rather than the subprime mortgages. It is the derivative obligations of AIG that implode the insurer. With the fear of contagion, US government issued billions of dollars to bailout AIG counterparties---the biggest banks of Europe and America. Without the bailout, banks on Wallstreet have gone to bankruptcy, followed with bunch of European and Asian banks.

Not like AIG and other banks on Wallstreet which could have been allowed bankruptcy, the derivatives closely tied with FDIC insured division make the obligations have to be paid by US government. There is no choice for except the default. Bank of America is insured by FDIC, with the protection of the Federal Reserve. When obligations are triggered, FDIC and counterparties of Bank of America will be bailed out as guaranteed by the US government credit. Therefore, the risks are directly transferred to taxpayers and dollar savers.

It is a good case in point that the bank-controlled entity poses power over nation’s credit system. After financial crisis in 2008 such power has become more rather than less and the instability problem still exists. Another example is JP Morgan is allowed to issue derivatives insured by FDIC retail banking Unit. With such power over the national monetary the taxpayers and savers will never be protected.

The Application of the Weighted Average Cost of Capital

With the gradual increase of the income approach used in our assessment practices, new issues are also gradually increasing. Income approach as before most of the appraisers as best placed to exploit the assets of Canadian and French historical cost as the basis, but needs more analysis and judgment, there is more change and uncertainty. What is the importance for the business is raising finance. Therefore, which choice for the Business; Equity Capital or debt Finance? With the increase of the risks, the cost of capital is also on the way of increasing. However, if we use the WACC, we could have the similar result as before.

Therefore, the Weighted Average Cost of Capital (WACC) is more applied at the present. WACC used to measure a company's cost of capital in financial activities. Because the cost of financing is seen as a logical price tag, it was used as a discount rate of financing projects. WACC reflecting the average cost of a company through equity and debt financing, project financing, the rate of return must be higher than the weighted average cost of capital investment value.

As an example, Eurozone seeks central banks' help in Greek bail-out. Eurozone governments are looking to the European Central Bank and national central banks to help pare back the cost of a second rescue package for Greece which would otherwise amount €170bn.

                                         

Figures seen by the Financial Times reveal Greece needs €136bn in fresh bail-out funding from the European Union and International Monetary Fund – in addition to the €34bn left over from Greece’s first bail-out. This is €6bn more than EU leaders agreed in October. Germany, the Netherlands and Finland have insisted on paying no more than €130bn.

All of these phenomenons tell us the information that the Eurozone have many crises needs to be solved moreover only seeking the help from the central bank. Firstly, they should take the necessary measures to stabilize the people's heart has been affected by the situation as soon as possible. Secondly, some unnecessary expenditure should reduce or avoid, which is a kind of measure to reduce the cost of margin. Thirdly, the relevant government should be prepared to investigate and develop some new projects, then can make it back on track and re-make a profit, which make the real sense of getting rid of the present situation and take a new lease of life.

In my opinion, although this news is refers to the European government; however, we could considered it as a larger version of evolution assistance and financing from the financial crisis. They play the roles for the Government National Banks instead of the companies. In another way, the Eurozone should show its profitability and the control the relevant.

From the above case, it could help us to find the application of the WACC in the real world more than understanding the definition in the book and explain the reason for the decision making and how to apply the WACC to evaluate the business. The application of the WACC is various and useful, it can decide that the project evaluation method of operation, which has a very important reference value and the actual role.

Sources: Global Economy, The Financial Times, BBC News.