What determines dividend policy: A comprehensive test
Tao Zeng. Journal of American Academy of Business, Cambridge. Hollywood: Mar 2003. Vol. 2
“This paper designs an empirical work to investigate the determinants of corporate dividend policy under the Canadian situation. It shows that firms pay dividend as a signal and to reduce agency costs. It also shows that liquidity and tax clientele effect are related to dividend policy”
1. INTRODUCTION
à There is a big deal “Why firms pay dividend”
à Why? Some researchers:
Dividend as servers as signal to shareholders
Can reduce agency cost and enforce manager to act in the interest shareholders
Because clientele effects exist
à This research differs from prior researches on 3 important ways:
1. Examines the relationship between firm-specific characteristic and dividend policy
2. This study designs the test using corporate financial data, rather than taking a surveys study.
3. This study makes comprehensive test of the determinant of dividend policy
2. THE FACTORS EFFECTING DIVIDEND POLICY
2.1. Tax clientele à . Tax clientele hypothesis argues that tax clienteles prefer different dividend policies, and investors may attach to firms that have dividend policies appropriate to their particular tax circumstance
2.2. Agency cost à dividend gives a mechanism for restricting managerial discretion. It reduces the agency cost of free cash flow by cutting down the cash available for spending at the discretion of management.
2.3. Signaling à dividend are paid to communicate information to investors about firm future prospect
2.4. Corporate liquidityà . A high degree of liquidity might be expected to encourage dividends by enabling high dividends to be paid without resort to external finance
3. TEST METHOD, DATA COLLECTION AND VARIABLES
3.1. Data collection and variables
à Data collected from “Canadian Financial Post Card” years 1984-88
Sample: firm that have criteria (1) availability of accounting data on the financial Post Card for the time period of 6 years from 1984-88 (2)not in the financial, insurance or real estate à 313 company from 1565 observation
Hypothesis: dividend payout is positively related to the percentage of major institutional shareholders, and negatively related to the percentage of major individual shareholders
à Variables:
Dividend paid or declared per share
Dividend payout ratio
Dividend yield
3.2. Test method
à First classifying firm into two groups; those who paying dividend (242) firm and not (71 firm) à compare the means à assessed using a t-test for each à *see the paper – can not be simply*
4. RESULTS (The results are shown in table 1-6)
4.1. Tax clientele àfirms paying dividends have significantly higher institutional ownership than firms not paying dividends and the individual ownership for pay-- dividend firms are lower but not significantly than non-paying-dividend firms.
4.2. Agency cost àfirm size is significantly positively related to dividend per share or dividend yield and positively correlated to agency cost
4.3. Signaling à current earnings and cash flow can estimate share price much better for firms not paying dividends than firms paying dividends.
4.4. Liquidity à the evidence that strongly supports the liquidity hypothesis
4.5. Other results à ***
5. CONCLUSION
This paper examines the determinants of dividend policy in the Canadian situation. It is argued that there may exist benefits for paying dividends, in order to compensate the tax disadvantage. Paying dividends may communicate additional information about firms= future profitability - signaling hypothesis. Dividends may be paid to tax-exempt or tax-deferred investors, or investors with lower effective tax rate - tax clientele hypothesis. Dividends may also be used to bond managerial discretionary behavior - agency theory. Finally, firms may pay dividends if no investment opportunities available - liquidity hypothesis
Kamis, 10 April 2008
What determines dividend policy: A comprehensive test"article"
What determines dividend policy: A comprehensive test
Tao Zeng. Journal of American Academy of Business, Cambridge. Hollywood: Mar 2003. Vol. 2, Edisi 2; pg. 304, 6 pgs
Abstrak (Ringkasan)
This paper designs an empirical work to investigate the determinants of corporate dividend policy under the Canadian situation. It shows that firms pay dividend as a signal and to reduce agency costs. It also shows that liquidity and tax clientele effect are related to dividend policy.
» Lompat ke pengindeksan (detil dokumen)
Teks Lengkap (3792 kata)
Copyright Journal of American Academy of Business Mar 2003
[Headnote]
ABSTRACT
[Headnote]
This paper designs an empirical work to investigate the determinants of corporate dividend policy under the Canadian situation. It shows that firms pay dividend as a signal and to reduce agency costs. It also shows that liquidity and tax clientele effect are related to dividend policy.
1. INTRODUCTION
There has been a great deal of financial, economic, as well as accounting literature analysing why firms pay dividends, given the fact that effective tax rate on capital gains lower than the effective tax rate on dividends, i.e., the Adividend puzzle@ (Holder et al 1998, Dhaliwal et al 1995, Lamoureux 1990, Chaplinsky and Seyhun 1990, Abrutyn and Turner 1990, Mann 1989, Crockett and Friend 1988, Kose and Williams 1985, Feldstein and Green 1983, Litzenberger and Ramaswamy 1982, 1979, Miller and Scholes 1982, Feldstein 1970, and so on). To shed light on this puzzle, researchers try to figure out the benefits from paying dividends, which may offset the tax disadvantages. Some survey studies find that CEOs choose to pay dividends because they believe dividend can server as a signal to shareholders (Baker and Powell 1999, Abrutyn and Turner 1990, Baker et al 1985); because dividend can reduce agency costs and enforce manager to act in the interest of shareholders (Abrutyn and Turner 1990); because clientele effects exist (Baker et al 1985). Some event studies on signalling effect attempt to test whether a positive equity price response is associated with unexpected dividend increase, or vice visa. Several studies present evidence consistent with this argument (Dielman and Oppenheimer 1984, Aharony and Swary 1980, Charest 1978, Pettit 1977, 1972). Some studies, however, do not find the evidence indicate that dividend changes reflect no more information than that reflected in earnings (Gonedes 1978). Tax clientele studies (Dhaliwal et al 1995) argue that the ownership by tax-exempt or tax deferred investors will increase when firms begin to pay dividends. This study differs from prior researches on 3 important ways. First, this paper examines the relationship between firm-specific characteristics and dividend policy. Mann (1989) argued that studies should go beyond event studies around dividend announcement days since there may exist underlying factors other than dividend itself that drive the change of return around dividend announcement. Second, this study designs the tests using corporate financial data, rather than taking a survey study. The argument from survey may provide reasons justifying the managers' behaviour afterwards, rather than a motive beforehand. In addition, survey research involves non-- response bias, and the bias is severe when the response rate is low. Third, this study makes a comprehensive test of the determinants of dividend policy. Prior researches usually focus on only one factor, e.g., signalling (Dyl and Weigand 1998, Brook et al 1998, Bernheim and Wantz 1985), agency cost (Born and Rimbey 1993, Crutchley and Hansen 1989, Easterbrook 1984), tax clientele (Dhaliwal et al 1995, Scholz 1992), or investment opportunity (Gaver and Gaver 1993, Smith and Watts 1992). It is argued that dividend policy may be a decision based on the combination of many factors inside and outside. The remainder of this paper is organized as follows. In section 2, I review the literature relevant to the determinants of firms dividend policies. In section 3, I provide the empirical test method, data collection and variable measurement. In section 4, the test results are presented. Finally, I summarize and conclude in section 5.
2. THE FACTORS EFFECTING DIVIDEND POLICY
Given the effective tax rate on capital gains lower than that on dividends, researches have been taken to figure out the benefits from paying dividends, which may compensate the tax disadvantages. The benefits from pay dividends or the reasons justifying dividend payoff are summarized as follows:
2.1. Tax clientele
One argument of why firms pay dividends involves tax effect. Shareholders receive and are taxed the returns to shares either as dividends or capital gains. Dividends and capital gains are taxed differently among various types of investors, individual investors, corporate investors, and tax-exempt or tax-deferred investors. Tax clientele hypothesis argues that tax clienteles prefer different dividend policies, and investors may attach to firms that have dividend policies appropriate to their particular tax circumstance. For example, corporate investors, whose dividends are taxed at a lower rate than capital gains, may prefer high dividend payout ratio; on the other hand, high-income individual investors, whose dividends are taxed at a higher rate than capital gains, may prefer low dividend payout ratio. The tests in this study for tax clientele hypothesis are that: positive relationship between firm dividend payoff and the ownership of corporate investors and tax-exempt or tax-deferred investors; a negative relationship between firm dividend payoff and the ownership of high-income individual investors.
2.2. Agency cost
Another argument of why firms pay dividends is that dividends provide a mechanism for restricting managerial discretion. It reduces the agency costs of free cash flow by cutting down the cash available for spending at the discretion of management, and hence provide some protections to the firm against management that might benefit itself at the shareholders= expenses. If firm size is positively related to diversification and decentralization, then the lager the firm, the less observable the actions of management and the higher agency costs may be incurred. Hence I may expect large firms pay dividends. Also, Gaver and Gaver (1993) argue that when the firm growth opportunities increase, the observability of managerial action decrease. It is difficult for outsiders like shareholders, without inside information and specified knowledge of managers, to ascertain the growth opportunities available to the firm. In contrast, maintenance and supervision of existing assets are more readily observable. If the managerial actions are less observable, the agency costs may be higher, and we expect the firm may rely on dividends to restrict managerial discretion. Hence we expect growth firms pursue a high dividend payout policy.
2.3. Signalling
Signalling hypothesis argues that dividends are paid to communicate information to investors about firms future prospects. Under information asymmetry, insiders are better informed than outsider investors. If managers have information that outside investors do not have, they may use dividends as a way to signal this private information and reduce information asymmetry. Dividends may affect firm market value because they may signal favourable inside information. Hence insider will pay dividends to communicate information and achieve a higher market price for the firm-s stocks than would otherwise prevail. To serve as a signal, dividend payout must provide the market with the useful information which can not be conveyed by alternative forms of communication, e.g., current earnings and cash flow. The test in this study is to examine whether dividend payoff provide an improved estimate of firm's stock price.
2.4. Corporate liquidity
Liquidity requirement may also affect firms= dividend decisions. A high degree of liquidity might be expected to encourage dividends by enabling high dividends to be paid without resort to external finance. Firms' free cash flows may be used as an indicator of firms' liquidity, and the test is that high degree of free cash flow encourage high dividend payments. If leverage is used as one indicator of the future default, and positively related to the costs of financial costs, when the firm's leverage ratio is high, and dividend payoff may increase financial distress, firms may reluctant to pay dividends. To increase liquidity, firms might lower dividend payments. The test in this study is the inverse relationship between firm leverage and dividend payoff. Also, if firms have significant opportunities, they may undertake the opportunities rather than paying dividends. Hence growth firms are expected to pursue a low dividend payout policy (Gaver and Gaver 1993).
3. TEST METHOD, DATA COLLECTION AND VARIABLES
3.1. Data collection and variables
I collect data on the "Canadian Financial Post Card" for the years of 1984-88. The sample consists of all firms that meet the following criteria: (1) availability of accounting data on the Financial Post Card for the time period of 6 years from 1984 to 1988; (2) not in the financial, insurance, or real estate industries. There are 313 companies, i.e., 1565 observations. The variables used to test the propositions are as follows: To test tax clientele hypothesis, I have to specify the corporate investor, tax-exempt or tax-deferred investors, and high-income individual investors. The institutional investors may represent the corporate investor and tax-exempt or tax-deferred investors. The institutional investors include companies, banks, insurance, pension plans, and trust investors. I look up the major shareholders for each firm around 1986 on the financial post card, and calculate the percentage of major institutional shareholders to all shareholders. I also calculate the percentage of major individual shareholders to all shareholders. It is argued that, if an individual is a major shareholder, he may be expected to be in a high-- income bracket. The hypothesis is that dividend payout is positively related to the percentage of major institutional shareholders, and negatively related to the percentage of major individual shareholders. There are 3 variables to measure dividend policy: (1). dividend paid or declared per share, (2). dividend payout ratio (dividend per share divided by after-tax earnings per share), and (3). dividend yield (dividend per share divided by share price).
1. is the dividend paid or declared per share, calculated by the total common stock dividend payment divided by total common share outstanding. To make it comparable over the five year time periods, the dividend per share calculated above will be multiplied by the split number, when firms split shares. For example, for a 2-for-1 split, (1) is calculated by the total common stock dividend payout divided by total common shares outstanding (after split), times 2.
2. is calculated by total common stock dividend payment divided by total common share outstanding, divided by earnings after tax and before extraordinary items divided by total common share outstanding. It is the same as the total common stock dividend payment divided by earnings after tax and before extraordinary items. To use this measure, negative earnings should be deleted.
3. is calculated by total common stock dividend payout divided by total common shares outstanding, divided by share price. Share price is measured as the average high price and low price in the year. The high and low prices are obtained from the historical data statistics on the financial post card.
In this study, I use (1) and (3) measures since using (2) has to delete the observations with negative earnings and hence lose some observations. Firm size is measured as the log of operating revenue. The agency cost hypothesis is that firm size is positively related to dividend payments. One liquidity indicator is firm free cash flow, which is measured as the cash flow from operation. It is deflated by total asset value to avoid size effect. The liquidity hypothesis suggests that free cash flow is positively related to dividend payout. Another liquidity indicator is investment/cash flow ratio: the change of capital properties (land, building, and equipments), divided by cash flow from operation. If a firm with low cash flow level makes a great deal of investment in fixed assets, it may incur liquidity problem. The liquidity hypothesis suggests that high investment/cash flow ratio disencourages dividend payout. Leverage is measured as the sum of short term and long term debt, divided by total asset value. The liquidity hypothesis suggests that leverage is negatively related to dividend payments. Firm growth has a mixed prediction. On the one hand, firms with investment opportunities may incurred higher agency costs since monitoring managerial actions of choosing new investment projects is more difficult for outside shareholders than maintaining existing assets. Agency hypothesis suggests that growth firms may have higher dividends. On the other hand, firms with promising investment opportunities may undertake these opportunities rather than paying dividends. Given the assumption of investment and dividends are linked through the firm=s cash flow identity, the liquidity hypothesis expects lower dividend payments with growth firms. I following Smith and Watt (1992) and measure growth opportunity as the market-to-book ratio: firm market value divided by total asset value. They argue that the lower the market-to-book ratio, the higher the ratio of asset in place to firm value, and the lower the ratio of growth opportunities to firm value.
3.2. Test method
First, I classify firms into two groups: those paying dividends (242 firms), and those not paying dividends since 1980 (71 firms). I compare the means for theses two groups. The significance of the difference in the means for these two groups is assessed using a t-test. For each group, we regress share price on current after-tax earnings and cash flow, and compare the R-- squared values. For firms paying dividend, I also regress share price on current after-tax earnings and cash flow as well as current dividend payout, and compare the R-square with that obtained from the regression without current dividend payout. The null hypothesis is that the coefficient on the variable of current dividend payout is zero. Then I design a following linear regression model, where I regress dividend per share (or dividend yield) on institutional ownership, individual ownership, firm size, growth, leverage, and liquidity. To test tax clientele hypothesis, I use two variables: institutional ownership and individual ownership. To test agency theory, I use one variable: firm size. To test liquidity hypothesis, I use two variables: cash flow and leverage. I do not use the investment/cash flow ratio, because to use this variable, I have to delete the observations with negative cash flow, and hence lose some observations (106 observations). The growth variable can be used to test either the agency theory or the liquidity hypothesis, and its predicted sign is mixed. When I use dividend yield as dependent variable, I drop the market-- to-asset ratio variable. This is because the market-to-asset ratio relies on share price, and the inverse relationship between dividend yield and share price make it sensitive to the dividend policy of the firm.
4. RESULTS (The results are shown in table 1-6)
4.1. Tax clientele
Table 1 shows some evidence consistent with the tax clientele hypothesis: firms paying dividends have significantly higher institutional ownership than firms not paying dividends, and the individual ownership for pay-- dividend firms is lower but not significantly than non-paying-dividend firms.
4.2. Agency cost
Table 1 shows that the firms paying dividends is significantly larger than the firms not paying dividends. Table 3 and table 4 show that firm size is significantly positively related to dividend per share or dividend yield. If firm size is positively related to agency cost, then larger firms will have larger agency cost and more likely to resort to paying dividends to reduce this cost.
Perbesar 200%
Perbesar 400%
Table 1.
Table 2.
Table 3 and 4
4.3. Signalling
Table 1 shows that current earnings and cash flow can estimate share price much better for firms not paying dividends than firms paying dividends. The R-squared value for paying-dividends firms is 0.1419, while the R-- squared value for not-paying-dividend firms is 0.3086, about 2.2 times as large as paying-dividend firms. I also regress share price on current earnings, cash flow, and dividend per share for the firms paying dividends. The R-- squared value is 0.2836, which is two times as large as the R-squared value from the regression not using dividend variable. The null hypothesis that the coefficient on the current dividend per share variable is zero, is rejected at 0.001 level (F-test value=79.4772). I argue that the current accounting data i.e., earnings and cash flow for paying-- dividend firms do not predict share price as well as non-paying-dividend firms. This may justify the firms using dividend to communicate some relevant information that is not conveyed by current earnings and cash flow. When I add dividend payoff as an independent variable for the pay-dividend firms, the R-squared value is significantly improved, and dividend payoff can explain share price as well as the combination of earnings and cash flow.
4.4. Liquidity
Table 1 shows the evidence that strongly supports the liquidity hypothesis. It shows that pay-dividend firms have significantly lower investment/cash flow ratio and leverage (i.e., less liquidity problem) than non-pay-- dividend firms. Pay-dividend firms also have significantly higher level of free cash flow than non-paying-dividend firms. The regression results from Table 3 and 4 also support the liquidity hypothesis. It is shown that leverage is significantly negatively related to dividend per share and dividend yield; cash flow is significantly positively related to dividend payout measured either as dividend per share or dividend yield. A caveat is that the free cash flow variable may measure some agency problems since management with more free cash flow may has higher probability of discretionary use of this cash flow. The positive relationship between the free cash flow and dividends may confirm the agency theory, i.e., firms with high agency costs use dividends to bond managerial behaviour. Therefore, this positive relationship is consistent with either the liquidity hypothesis or the agency theory.
4.5. Other results
The growth variable can either be used to test the agency theory or be used to test the liquidity hypothesis. Tables 1 shows that, growth firms, measured as market-to-book ratio, do not pay dividends. It is consistent with the liquidity hypothesis. However, Table 2 shows the coefficient on the market-to-book ratio is not significant. Table 5 presents the correlation matrix of the independent variables. The smallest correlation is -0.5590 between institutional ownership and individual ownership, and the largest correlation is 0.1777 between liquidity and firm size. Only one correction have an absolute value larger than 0.3. This suggests that multi-collinearity is not a problem.
I also classify the time periods into two periods: 1984-1986, and 1987-1988, and test whether the 1987 tax reform changes the relationship between the independent variables and dividend policy. The regression results, which are not presented in this paper, show that the results do not change.
5. CONCLUSION
This paper examines the determinants of dividend policy in the Canadian situation. It is argued that there may exist benefits for paying dividends, in order to compensate the tax disadvantage. Paying dividends may communicate additional information about firms= future profitability - signalling hypothesis. Dividends may be paid to tax-exempt or tax-deferred investors, or investors with lower effective tax rate - tax clientele hypothesis. Dividends may also be used to bond managerial discretionary behaviour - agency theory. Finally, firms may pay dividends if no investment opportunities available - liquidity hypothesis. The empirical tests in this studies support the signalling hypothesis, the agency theory, and liquidity hypothesis. It also shows some evidence supporting the tax-clientele hypothesis, but the evidence is not strong. One improved test is to collect the institutional and individual ownership data year by year, and look at all shareholders rather than the major shareholders. Another extension of the study is to use a different time periods. This study uses the data for five years from 1984-1988. There are two reasons to choose this time period: (1) Cross-sectional test using only year data may not be appropriate because dividend payout policies may take time and be costly to achieve. (2) we seek to test whether the 1987 tax reform changes the hypothesises on the determinants dividend policy. Future study can be taken to collect data for the more recent years, and examine whether those hypothesises on the determinants of dividend policy are changed with the rapidly developed technology.
Perbesar 200%
Perbesar 400%
Table 5.
[Sidebar]
The Author gratefully acknowledges that financial support for this research was received from a grant funded by WLU Operating funds, the SSHRC Institutional Grant awarded to WLU, and CMA Canada - Ontario.
[Referensi]
REFERENCE
[Referensi]
Abrutyn, S. and R.W. Turner, Taxes and Firms Dividend Policies: Survey Results, National Tax Journal 43, 491-497 (1990).
Aharony, J. and 1. Swary, Quarterly Dividend and Earnings Announcements and Stockholders= Returns: An Empirical Analysis, Journal of Finance, 1-12 (1980).
Ambarish, R., Efficient Signalling with Dividends and Investment, Journal ofFinance 42, 321-343 (1987).
Baker, H.K., G.Farrelly and R.Edelman, A Survey of Management Views on Dividend Policy, Financial Management 14, 78-84 (1985).
Baker, H.K. and G.E. Powell, How Corporate Managers View Dividend Policy, Quantitative Journal of Business and Economics 38(2), 17-35 (Spring 1999).
Bernheim, B.D. and A.Wantz, A Tax-based Test of the Dividend Signalling Hypothesis, The American Economics Review 85(3), 532-551 (1985).
Born, J.A. and J.N. Rimbey, A Test of Easterbrook Hypothesis Regarding Dividend Payments and Agency Costs, The Journal of Financial Research 16(3), 251-260 (Fall 1993).
Chaplinsky, S. and H.N. Seyhun, Dividends and Taxes: Evidence on Tax-Reduction Strategies, Journal of Business 63(2), 239-258 (1990).
Charest, G., Dividend Information, Stock Returns and Market EfficiencyB II, Journal ofFinancial Economics, 297-330 (1978).
Crockett, J. and I. Friend, Dividend Policy in Perspective: Can Theory Explain Behaviour?, The Review of Economics and Statistics, 603-613 (1999).
[Referensi]
Crutchley, C.E. and R.S. Hansen, A Test of the Agency Theory of Managerial Ownership, Corporate Leverage, and Corporate Dividends, Financial Management 18(4), 36-46 (Winter 1989).
Dhaliwal, D.S., M. Erickson, and R. Trezevant, A Test of the Theory of Tax Clienteles for Dividend Policies, National Tax Journal 47, 179-194 (1995).
Dielman, T. and H. Oppenheimer, An Estimation of Investor Behaviour During Periods of Large Dividend Changes, Journal of Financial and Quantitative Analysis, 197-216 (1984).
Easterbrook, F., Two Agency Cost Explanations of Dividends, American Economics Review 74, 650-659 (1984). Feldstein, M and J. Green, Why do Companies pay Dividends? American Economics Review 73, 17-30 (1983).
Gaver, J.J. and K.M Gaver, Additional Evidence on the Association between the Investment Opportunity Set and Corporate Financing, Dividend, and Compensation Policies, Journal of Accounting and Economics 16, 125-160 (1993).
Gonedes, N., Corporate Signalling, External Accounting, and Capital Market Equilibrium: Evidence on Dividends, Income, and Extraordinary Items, Journal of Accounting Research, 26-79 (Spring 1978).
Gottardi, P., An analysis of the Conditions for the Validity of Modigliani-Miller Theorem with Incomplete Markets, Economic Theory 5, 191207 (Spring 1995).
Grundy, B.D., Preferred and Taxes: the Relative Price of Dividends and Coupons, Working Paper (September 1992).
Holder, M.E., Langrehr, F.W. and J.L. Hexter, Dividend Policy Determinants: An Investigation of the Influences of Stockholder Theory, Financial Management 27(3), 73-82 (Fall 1998).
Jensen, M.C. and W.H. Meckling, Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure, Journal of Financial Economics 3, 305-360 (1976).
Kose, J. and J. Williams, Dividends, Dilution, and Taxes: A Signalling Equilibrium, Journal ofFinance, 1053-1070 (1985). Lamoureux, C.G., Dividends, Taxes, and Normative Portfolio Theory, Journal of Economics and Business, 121-131 (1992).
Mackie-Mason, J.K., Do Taxes Affect Corporate Financing Decision? The Journal ofFinance, VoI.XLV, No.5, 1471-1493 (December 1990). Mann, S.V., The Dividend Puzzle: A Progress Report, Quarterly Journal of Business and Economics 28(3), 3-35 (1989).
Pettit, R., Taxes, Transaction Costs and Clientele Effect of Dividends, Journal ofFinancial Economics, 419-436 (1977).
Scholz, K.J., A Direct Examination of the Dividend Clientele Hypothesis, Journal ofPublic Economics 49, 261-285 (1992).
Wolfson, M.A., The Effects of Ownership and Control on Tax and Financial Reporting Policy, Economic Notes 22, 318-332 (1993).
[Afiliasi Pengarang]
Dr. Tao Zeng, Wilfrid Laurier University, Waterloo, Ontario, Canada
Tao Zeng. Journal of American Academy of Business, Cambridge. Hollywood: Mar 2003. Vol. 2, Edisi 2; pg. 304, 6 pgs
Abstrak (Ringkasan)
This paper designs an empirical work to investigate the determinants of corporate dividend policy under the Canadian situation. It shows that firms pay dividend as a signal and to reduce agency costs. It also shows that liquidity and tax clientele effect are related to dividend policy.
» Lompat ke pengindeksan (detil dokumen)
Teks Lengkap (3792 kata)
Copyright Journal of American Academy of Business Mar 2003
[Headnote]
ABSTRACT
[Headnote]
This paper designs an empirical work to investigate the determinants of corporate dividend policy under the Canadian situation. It shows that firms pay dividend as a signal and to reduce agency costs. It also shows that liquidity and tax clientele effect are related to dividend policy.
1. INTRODUCTION
There has been a great deal of financial, economic, as well as accounting literature analysing why firms pay dividends, given the fact that effective tax rate on capital gains lower than the effective tax rate on dividends, i.e., the Adividend puzzle@ (Holder et al 1998, Dhaliwal et al 1995, Lamoureux 1990, Chaplinsky and Seyhun 1990, Abrutyn and Turner 1990, Mann 1989, Crockett and Friend 1988, Kose and Williams 1985, Feldstein and Green 1983, Litzenberger and Ramaswamy 1982, 1979, Miller and Scholes 1982, Feldstein 1970, and so on). To shed light on this puzzle, researchers try to figure out the benefits from paying dividends, which may offset the tax disadvantages. Some survey studies find that CEOs choose to pay dividends because they believe dividend can server as a signal to shareholders (Baker and Powell 1999, Abrutyn and Turner 1990, Baker et al 1985); because dividend can reduce agency costs and enforce manager to act in the interest of shareholders (Abrutyn and Turner 1990); because clientele effects exist (Baker et al 1985). Some event studies on signalling effect attempt to test whether a positive equity price response is associated with unexpected dividend increase, or vice visa. Several studies present evidence consistent with this argument (Dielman and Oppenheimer 1984, Aharony and Swary 1980, Charest 1978, Pettit 1977, 1972). Some studies, however, do not find the evidence indicate that dividend changes reflect no more information than that reflected in earnings (Gonedes 1978). Tax clientele studies (Dhaliwal et al 1995) argue that the ownership by tax-exempt or tax deferred investors will increase when firms begin to pay dividends. This study differs from prior researches on 3 important ways. First, this paper examines the relationship between firm-specific characteristics and dividend policy. Mann (1989) argued that studies should go beyond event studies around dividend announcement days since there may exist underlying factors other than dividend itself that drive the change of return around dividend announcement. Second, this study designs the tests using corporate financial data, rather than taking a survey study. The argument from survey may provide reasons justifying the managers' behaviour afterwards, rather than a motive beforehand. In addition, survey research involves non-- response bias, and the bias is severe when the response rate is low. Third, this study makes a comprehensive test of the determinants of dividend policy. Prior researches usually focus on only one factor, e.g., signalling (Dyl and Weigand 1998, Brook et al 1998, Bernheim and Wantz 1985), agency cost (Born and Rimbey 1993, Crutchley and Hansen 1989, Easterbrook 1984), tax clientele (Dhaliwal et al 1995, Scholz 1992), or investment opportunity (Gaver and Gaver 1993, Smith and Watts 1992). It is argued that dividend policy may be a decision based on the combination of many factors inside and outside. The remainder of this paper is organized as follows. In section 2, I review the literature relevant to the determinants of firms dividend policies. In section 3, I provide the empirical test method, data collection and variable measurement. In section 4, the test results are presented. Finally, I summarize and conclude in section 5.
2. THE FACTORS EFFECTING DIVIDEND POLICY
Given the effective tax rate on capital gains lower than that on dividends, researches have been taken to figure out the benefits from paying dividends, which may compensate the tax disadvantages. The benefits from pay dividends or the reasons justifying dividend payoff are summarized as follows:
2.1. Tax clientele
One argument of why firms pay dividends involves tax effect. Shareholders receive and are taxed the returns to shares either as dividends or capital gains. Dividends and capital gains are taxed differently among various types of investors, individual investors, corporate investors, and tax-exempt or tax-deferred investors. Tax clientele hypothesis argues that tax clienteles prefer different dividend policies, and investors may attach to firms that have dividend policies appropriate to their particular tax circumstance. For example, corporate investors, whose dividends are taxed at a lower rate than capital gains, may prefer high dividend payout ratio; on the other hand, high-income individual investors, whose dividends are taxed at a higher rate than capital gains, may prefer low dividend payout ratio. The tests in this study for tax clientele hypothesis are that: positive relationship between firm dividend payoff and the ownership of corporate investors and tax-exempt or tax-deferred investors; a negative relationship between firm dividend payoff and the ownership of high-income individual investors.
2.2. Agency cost
Another argument of why firms pay dividends is that dividends provide a mechanism for restricting managerial discretion. It reduces the agency costs of free cash flow by cutting down the cash available for spending at the discretion of management, and hence provide some protections to the firm against management that might benefit itself at the shareholders= expenses. If firm size is positively related to diversification and decentralization, then the lager the firm, the less observable the actions of management and the higher agency costs may be incurred. Hence I may expect large firms pay dividends. Also, Gaver and Gaver (1993) argue that when the firm growth opportunities increase, the observability of managerial action decrease. It is difficult for outsiders like shareholders, without inside information and specified knowledge of managers, to ascertain the growth opportunities available to the firm. In contrast, maintenance and supervision of existing assets are more readily observable. If the managerial actions are less observable, the agency costs may be higher, and we expect the firm may rely on dividends to restrict managerial discretion. Hence we expect growth firms pursue a high dividend payout policy.
2.3. Signalling
Signalling hypothesis argues that dividends are paid to communicate information to investors about firms future prospects. Under information asymmetry, insiders are better informed than outsider investors. If managers have information that outside investors do not have, they may use dividends as a way to signal this private information and reduce information asymmetry. Dividends may affect firm market value because they may signal favourable inside information. Hence insider will pay dividends to communicate information and achieve a higher market price for the firm-s stocks than would otherwise prevail. To serve as a signal, dividend payout must provide the market with the useful information which can not be conveyed by alternative forms of communication, e.g., current earnings and cash flow. The test in this study is to examine whether dividend payoff provide an improved estimate of firm's stock price.
2.4. Corporate liquidity
Liquidity requirement may also affect firms= dividend decisions. A high degree of liquidity might be expected to encourage dividends by enabling high dividends to be paid without resort to external finance. Firms' free cash flows may be used as an indicator of firms' liquidity, and the test is that high degree of free cash flow encourage high dividend payments. If leverage is used as one indicator of the future default, and positively related to the costs of financial costs, when the firm's leverage ratio is high, and dividend payoff may increase financial distress, firms may reluctant to pay dividends. To increase liquidity, firms might lower dividend payments. The test in this study is the inverse relationship between firm leverage and dividend payoff. Also, if firms have significant opportunities, they may undertake the opportunities rather than paying dividends. Hence growth firms are expected to pursue a low dividend payout policy (Gaver and Gaver 1993).
3. TEST METHOD, DATA COLLECTION AND VARIABLES
3.1. Data collection and variables
I collect data on the "Canadian Financial Post Card" for the years of 1984-88. The sample consists of all firms that meet the following criteria: (1) availability of accounting data on the Financial Post Card for the time period of 6 years from 1984 to 1988; (2) not in the financial, insurance, or real estate industries. There are 313 companies, i.e., 1565 observations. The variables used to test the propositions are as follows: To test tax clientele hypothesis, I have to specify the corporate investor, tax-exempt or tax-deferred investors, and high-income individual investors. The institutional investors may represent the corporate investor and tax-exempt or tax-deferred investors. The institutional investors include companies, banks, insurance, pension plans, and trust investors. I look up the major shareholders for each firm around 1986 on the financial post card, and calculate the percentage of major institutional shareholders to all shareholders. I also calculate the percentage of major individual shareholders to all shareholders. It is argued that, if an individual is a major shareholder, he may be expected to be in a high-- income bracket. The hypothesis is that dividend payout is positively related to the percentage of major institutional shareholders, and negatively related to the percentage of major individual shareholders. There are 3 variables to measure dividend policy: (1). dividend paid or declared per share, (2). dividend payout ratio (dividend per share divided by after-tax earnings per share), and (3). dividend yield (dividend per share divided by share price).
1. is the dividend paid or declared per share, calculated by the total common stock dividend payment divided by total common share outstanding. To make it comparable over the five year time periods, the dividend per share calculated above will be multiplied by the split number, when firms split shares. For example, for a 2-for-1 split, (1) is calculated by the total common stock dividend payout divided by total common shares outstanding (after split), times 2.
2. is calculated by total common stock dividend payment divided by total common share outstanding, divided by earnings after tax and before extraordinary items divided by total common share outstanding. It is the same as the total common stock dividend payment divided by earnings after tax and before extraordinary items. To use this measure, negative earnings should be deleted.
3. is calculated by total common stock dividend payout divided by total common shares outstanding, divided by share price. Share price is measured as the average high price and low price in the year. The high and low prices are obtained from the historical data statistics on the financial post card.
In this study, I use (1) and (3) measures since using (2) has to delete the observations with negative earnings and hence lose some observations. Firm size is measured as the log of operating revenue. The agency cost hypothesis is that firm size is positively related to dividend payments. One liquidity indicator is firm free cash flow, which is measured as the cash flow from operation. It is deflated by total asset value to avoid size effect. The liquidity hypothesis suggests that free cash flow is positively related to dividend payout. Another liquidity indicator is investment/cash flow ratio: the change of capital properties (land, building, and equipments), divided by cash flow from operation. If a firm with low cash flow level makes a great deal of investment in fixed assets, it may incur liquidity problem. The liquidity hypothesis suggests that high investment/cash flow ratio disencourages dividend payout. Leverage is measured as the sum of short term and long term debt, divided by total asset value. The liquidity hypothesis suggests that leverage is negatively related to dividend payments. Firm growth has a mixed prediction. On the one hand, firms with investment opportunities may incurred higher agency costs since monitoring managerial actions of choosing new investment projects is more difficult for outside shareholders than maintaining existing assets. Agency hypothesis suggests that growth firms may have higher dividends. On the other hand, firms with promising investment opportunities may undertake these opportunities rather than paying dividends. Given the assumption of investment and dividends are linked through the firm=s cash flow identity, the liquidity hypothesis expects lower dividend payments with growth firms. I following Smith and Watt (1992) and measure growth opportunity as the market-to-book ratio: firm market value divided by total asset value. They argue that the lower the market-to-book ratio, the higher the ratio of asset in place to firm value, and the lower the ratio of growth opportunities to firm value.
3.2. Test method
First, I classify firms into two groups: those paying dividends (242 firms), and those not paying dividends since 1980 (71 firms). I compare the means for theses two groups. The significance of the difference in the means for these two groups is assessed using a t-test. For each group, we regress share price on current after-tax earnings and cash flow, and compare the R-- squared values. For firms paying dividend, I also regress share price on current after-tax earnings and cash flow as well as current dividend payout, and compare the R-square with that obtained from the regression without current dividend payout. The null hypothesis is that the coefficient on the variable of current dividend payout is zero. Then I design a following linear regression model, where I regress dividend per share (or dividend yield) on institutional ownership, individual ownership, firm size, growth, leverage, and liquidity. To test tax clientele hypothesis, I use two variables: institutional ownership and individual ownership. To test agency theory, I use one variable: firm size. To test liquidity hypothesis, I use two variables: cash flow and leverage. I do not use the investment/cash flow ratio, because to use this variable, I have to delete the observations with negative cash flow, and hence lose some observations (106 observations). The growth variable can be used to test either the agency theory or the liquidity hypothesis, and its predicted sign is mixed. When I use dividend yield as dependent variable, I drop the market-- to-asset ratio variable. This is because the market-to-asset ratio relies on share price, and the inverse relationship between dividend yield and share price make it sensitive to the dividend policy of the firm.
4. RESULTS (The results are shown in table 1-6)
4.1. Tax clientele
Table 1 shows some evidence consistent with the tax clientele hypothesis: firms paying dividends have significantly higher institutional ownership than firms not paying dividends, and the individual ownership for pay-- dividend firms is lower but not significantly than non-paying-dividend firms.
4.2. Agency cost
Table 1 shows that the firms paying dividends is significantly larger than the firms not paying dividends. Table 3 and table 4 show that firm size is significantly positively related to dividend per share or dividend yield. If firm size is positively related to agency cost, then larger firms will have larger agency cost and more likely to resort to paying dividends to reduce this cost.
Perbesar 200%
Perbesar 400%
Table 1.
Table 2.
Table 3 and 4
4.3. Signalling
Table 1 shows that current earnings and cash flow can estimate share price much better for firms not paying dividends than firms paying dividends. The R-squared value for paying-dividends firms is 0.1419, while the R-- squared value for not-paying-dividend firms is 0.3086, about 2.2 times as large as paying-dividend firms. I also regress share price on current earnings, cash flow, and dividend per share for the firms paying dividends. The R-- squared value is 0.2836, which is two times as large as the R-squared value from the regression not using dividend variable. The null hypothesis that the coefficient on the current dividend per share variable is zero, is rejected at 0.001 level (F-test value=79.4772). I argue that the current accounting data i.e., earnings and cash flow for paying-- dividend firms do not predict share price as well as non-paying-dividend firms. This may justify the firms using dividend to communicate some relevant information that is not conveyed by current earnings and cash flow. When I add dividend payoff as an independent variable for the pay-dividend firms, the R-squared value is significantly improved, and dividend payoff can explain share price as well as the combination of earnings and cash flow.
4.4. Liquidity
Table 1 shows the evidence that strongly supports the liquidity hypothesis. It shows that pay-dividend firms have significantly lower investment/cash flow ratio and leverage (i.e., less liquidity problem) than non-pay-- dividend firms. Pay-dividend firms also have significantly higher level of free cash flow than non-paying-dividend firms. The regression results from Table 3 and 4 also support the liquidity hypothesis. It is shown that leverage is significantly negatively related to dividend per share and dividend yield; cash flow is significantly positively related to dividend payout measured either as dividend per share or dividend yield. A caveat is that the free cash flow variable may measure some agency problems since management with more free cash flow may has higher probability of discretionary use of this cash flow. The positive relationship between the free cash flow and dividends may confirm the agency theory, i.e., firms with high agency costs use dividends to bond managerial behaviour. Therefore, this positive relationship is consistent with either the liquidity hypothesis or the agency theory.
4.5. Other results
The growth variable can either be used to test the agency theory or be used to test the liquidity hypothesis. Tables 1 shows that, growth firms, measured as market-to-book ratio, do not pay dividends. It is consistent with the liquidity hypothesis. However, Table 2 shows the coefficient on the market-to-book ratio is not significant. Table 5 presents the correlation matrix of the independent variables. The smallest correlation is -0.5590 between institutional ownership and individual ownership, and the largest correlation is 0.1777 between liquidity and firm size. Only one correction have an absolute value larger than 0.3. This suggests that multi-collinearity is not a problem.
I also classify the time periods into two periods: 1984-1986, and 1987-1988, and test whether the 1987 tax reform changes the relationship between the independent variables and dividend policy. The regression results, which are not presented in this paper, show that the results do not change.
5. CONCLUSION
This paper examines the determinants of dividend policy in the Canadian situation. It is argued that there may exist benefits for paying dividends, in order to compensate the tax disadvantage. Paying dividends may communicate additional information about firms= future profitability - signalling hypothesis. Dividends may be paid to tax-exempt or tax-deferred investors, or investors with lower effective tax rate - tax clientele hypothesis. Dividends may also be used to bond managerial discretionary behaviour - agency theory. Finally, firms may pay dividends if no investment opportunities available - liquidity hypothesis. The empirical tests in this studies support the signalling hypothesis, the agency theory, and liquidity hypothesis. It also shows some evidence supporting the tax-clientele hypothesis, but the evidence is not strong. One improved test is to collect the institutional and individual ownership data year by year, and look at all shareholders rather than the major shareholders. Another extension of the study is to use a different time periods. This study uses the data for five years from 1984-1988. There are two reasons to choose this time period: (1) Cross-sectional test using only year data may not be appropriate because dividend payout policies may take time and be costly to achieve. (2) we seek to test whether the 1987 tax reform changes the hypothesises on the determinants dividend policy. Future study can be taken to collect data for the more recent years, and examine whether those hypothesises on the determinants of dividend policy are changed with the rapidly developed technology.
Perbesar 200%
Perbesar 400%
Table 5.
[Sidebar]
The Author gratefully acknowledges that financial support for this research was received from a grant funded by WLU Operating funds, the SSHRC Institutional Grant awarded to WLU, and CMA Canada - Ontario.
[Referensi]
REFERENCE
[Referensi]
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Born, J.A. and J.N. Rimbey, A Test of Easterbrook Hypothesis Regarding Dividend Payments and Agency Costs, The Journal of Financial Research 16(3), 251-260 (Fall 1993).
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Charest, G., Dividend Information, Stock Returns and Market EfficiencyB II, Journal ofFinancial Economics, 297-330 (1978).
Crockett, J. and I. Friend, Dividend Policy in Perspective: Can Theory Explain Behaviour?, The Review of Economics and Statistics, 603-613 (1999).
[Referensi]
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Dhaliwal, D.S., M. Erickson, and R. Trezevant, A Test of the Theory of Tax Clienteles for Dividend Policies, National Tax Journal 47, 179-194 (1995).
Dielman, T. and H. Oppenheimer, An Estimation of Investor Behaviour During Periods of Large Dividend Changes, Journal of Financial and Quantitative Analysis, 197-216 (1984).
Easterbrook, F., Two Agency Cost Explanations of Dividends, American Economics Review 74, 650-659 (1984). Feldstein, M and J. Green, Why do Companies pay Dividends? American Economics Review 73, 17-30 (1983).
Gaver, J.J. and K.M Gaver, Additional Evidence on the Association between the Investment Opportunity Set and Corporate Financing, Dividend, and Compensation Policies, Journal of Accounting and Economics 16, 125-160 (1993).
Gonedes, N., Corporate Signalling, External Accounting, and Capital Market Equilibrium: Evidence on Dividends, Income, and Extraordinary Items, Journal of Accounting Research, 26-79 (Spring 1978).
Gottardi, P., An analysis of the Conditions for the Validity of Modigliani-Miller Theorem with Incomplete Markets, Economic Theory 5, 191207 (Spring 1995).
Grundy, B.D., Preferred and Taxes: the Relative Price of Dividends and Coupons, Working Paper (September 1992).
Holder, M.E., Langrehr, F.W. and J.L. Hexter, Dividend Policy Determinants: An Investigation of the Influences of Stockholder Theory, Financial Management 27(3), 73-82 (Fall 1998).
Jensen, M.C. and W.H. Meckling, Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure, Journal of Financial Economics 3, 305-360 (1976).
Kose, J. and J. Williams, Dividends, Dilution, and Taxes: A Signalling Equilibrium, Journal ofFinance, 1053-1070 (1985). Lamoureux, C.G., Dividends, Taxes, and Normative Portfolio Theory, Journal of Economics and Business, 121-131 (1992).
Mackie-Mason, J.K., Do Taxes Affect Corporate Financing Decision? The Journal ofFinance, VoI.XLV, No.5, 1471-1493 (December 1990). Mann, S.V., The Dividend Puzzle: A Progress Report, Quarterly Journal of Business and Economics 28(3), 3-35 (1989).
Pettit, R., Taxes, Transaction Costs and Clientele Effect of Dividends, Journal ofFinancial Economics, 419-436 (1977).
Scholz, K.J., A Direct Examination of the Dividend Clientele Hypothesis, Journal ofPublic Economics 49, 261-285 (1992).
Wolfson, M.A., The Effects of Ownership and Control on Tax and Financial Reporting Policy, Economic Notes 22, 318-332 (1993).
[Afiliasi Pengarang]
Dr. Tao Zeng, Wilfrid Laurier University, Waterloo, Ontario, Canada
THE EFFECT OF ASYSMATIC INFORMATION ON THE DIVIDEND POLICY
THE EFFECT OF ASYSMATIC INFORMATION ON THE DIVIDEND POLICY
INTRODUCTION
Based an empirical research about the dividendàwe know little about how firm set the policy àcan be classified into at least three categories about market imperfection:
Agency cost: arise from a cost associated with monitoring managers and/or from risk aversion on the part of managers
asymmetric information: provide a signaling rationale (signaling literature suggest that dividend convey information about current and future earning) for dividend
Transaction cost: can be minimizing with new capital issue by restricting dividend to fund not requires for investment purposes.
This paper--.empirically examine an alternative explanation of dividend policy based on asymmetric informationàthe alternative explanation is based on implication of the pecking order theory.
ASYSMATIC INFORMATION, TESTABLE HYPHOTHESES, AND CONTROL VARIABLES
Pecking order theory
Firm can reduce underinvestment and resulting ex-ante loss in firm valueà accumulating slack through retentionàby decreasing its dividend
“Dividend policy has power to control”
Signaling theory
“A substantial part of the theoretical literature on asymmetric information and dividend policy provides a signaling rationale for dividend:à higher dividend=higher earning. --> Dividend indirectly serves as a signal of future earning of the firm
Note: the pecking order theory and the signaling theory provide opposite prediction regarding the effect of the level of asymmetric information on dividend policy and thus provide a basis to distinguish between them.
Control variables
Several effects that identified, from other model on dividend policy
Agency cost of (External) equity
Dividend payment may serve as a mechanism to reduce agency cost of external equity
Dividend payment as bonding device used to reduce agency cost
Growth of investment opportunities
The higher the growth opportunities of the firm, the lower of dividends.
Note: the growth measure (MTOB), defined as the ratio of the market value of assets to the book value of the assets, is used as a proxy for growth opportunities.
Cash flow
à Residual theory: firm higher cash flow will pay higher dividends (firm with higher earning will pay higher dividend
à Pecking order theory: a higher cash flow from existing assets will translate into higher dividends as the need for slack is now lower.
Agency cost of Debt and Financing Distress
“Dividend also can see become a source of conflict between the stockholder and the debt holder of the firm and may give rise to agency cost of debt”.
“firm with likelihood higher of financial distress may pa lower dividends”
EMPIRICAL SPECIFICATION, METHODOLOGY, and MEASURES FOR THE DEPENDEND VARIABLES
Dependent Variables measures
Conventional dividend yield (DIVYLD) that equal the ratio of dividend per share to price per shareà dependent data à that measured dividend yield for dividend-paying firm and equal zero for non-dividend-paying firms [not use dividend payout ratio as dependent data]
Data
Dataà get from the industrial annual COMPUSTAT database for period 1988-1992
Sample à manufacturing firm (SIC 2000-3999) that trade on either the NYSE or the AMEX
Empirical result
à Estimating using the a Tobit model
à Dependent variable is Dividend yield
Independent variable used is insider ownership variable
à Analysis:
o The positive coefficient on analyst following (LOGANAL) suggest firm with less asymmetric information pay higher dividend (consistent with pecking order theory but not to signaling theory)
o The negative coefficient on growth measure (MTOB) and also positive coefficient on the cash flow measure – consistent with pecking order theory
o The positive coefficient on DIST suggest that firm with low cahflow and growth will pay higher dividend
Dividend policy and insider ownership
“Dividends are unrelated to the insider ownership variables”à pervious studies document a negative relation between dividend and insider ownership
à In other world, the previous findings on the role of insider ownership in determining dividend policy appear to be more strongly related to asymmetric information than to agency cost.
Dividend policy and Equity issue: A further test of the pecking order theory
Pecking order theory suggest: that firm should exhaust their internal fund before resorting to external financing
These result suggest that firm that resort to external resources for funds attempt to first exhaust their internal funds by paying lower dividend
Dividend policy and firm size
“There is a positive correlation between size and dividend policy”, logic think that firm size may serve as a proxy for asymmetric information where larger firm have less asymmetric information
Dividend policy, Asymmetric information, and issue cost
CONCLUSSION
àConssitent with pecking order theory:
· The positive relation between dividend and analyst
· Positive relation between dividend and cash flow and the negative realtion between dividend and growth opportunities
This paper provideà direct evidence à even though the implications of the pecking order theory for dividend policy are often discussed.
INTRODUCTION
Based an empirical research about the dividendàwe know little about how firm set the policy àcan be classified into at least three categories about market imperfection:
Agency cost: arise from a cost associated with monitoring managers and/or from risk aversion on the part of managers
asymmetric information: provide a signaling rationale (signaling literature suggest that dividend convey information about current and future earning) for dividend
Transaction cost: can be minimizing with new capital issue by restricting dividend to fund not requires for investment purposes.
This paper--.empirically examine an alternative explanation of dividend policy based on asymmetric informationàthe alternative explanation is based on implication of the pecking order theory.
ASYSMATIC INFORMATION, TESTABLE HYPHOTHESES, AND CONTROL VARIABLES
Pecking order theory
Firm can reduce underinvestment and resulting ex-ante loss in firm valueà accumulating slack through retentionàby decreasing its dividend
“Dividend policy has power to control”
Signaling theory
“A substantial part of the theoretical literature on asymmetric information and dividend policy provides a signaling rationale for dividend:à higher dividend=higher earning. --> Dividend indirectly serves as a signal of future earning of the firm
Note: the pecking order theory and the signaling theory provide opposite prediction regarding the effect of the level of asymmetric information on dividend policy and thus provide a basis to distinguish between them.
Control variables
Several effects that identified, from other model on dividend policy
Agency cost of (External) equity
Dividend payment may serve as a mechanism to reduce agency cost of external equity
Dividend payment as bonding device used to reduce agency cost
Growth of investment opportunities
The higher the growth opportunities of the firm, the lower of dividends.
Note: the growth measure (MTOB), defined as the ratio of the market value of assets to the book value of the assets, is used as a proxy for growth opportunities.
Cash flow
à Residual theory: firm higher cash flow will pay higher dividends (firm with higher earning will pay higher dividend
à Pecking order theory: a higher cash flow from existing assets will translate into higher dividends as the need for slack is now lower.
Agency cost of Debt and Financing Distress
“Dividend also can see become a source of conflict between the stockholder and the debt holder of the firm and may give rise to agency cost of debt”.
“firm with likelihood higher of financial distress may pa lower dividends”
EMPIRICAL SPECIFICATION, METHODOLOGY, and MEASURES FOR THE DEPENDEND VARIABLES
Dependent Variables measures
Conventional dividend yield (DIVYLD) that equal the ratio of dividend per share to price per shareà dependent data à that measured dividend yield for dividend-paying firm and equal zero for non-dividend-paying firms [not use dividend payout ratio as dependent data]
Data
Dataà get from the industrial annual COMPUSTAT database for period 1988-1992
Sample à manufacturing firm (SIC 2000-3999) that trade on either the NYSE or the AMEX
Empirical result
à Estimating using the a Tobit model
à Dependent variable is Dividend yield
Independent variable used is insider ownership variable
à Analysis:
o The positive coefficient on analyst following (LOGANAL) suggest firm with less asymmetric information pay higher dividend (consistent with pecking order theory but not to signaling theory)
o The negative coefficient on growth measure (MTOB) and also positive coefficient on the cash flow measure – consistent with pecking order theory
o The positive coefficient on DIST suggest that firm with low cahflow and growth will pay higher dividend
Dividend policy and insider ownership
“Dividends are unrelated to the insider ownership variables”à pervious studies document a negative relation between dividend and insider ownership
à In other world, the previous findings on the role of insider ownership in determining dividend policy appear to be more strongly related to asymmetric information than to agency cost.
Dividend policy and Equity issue: A further test of the pecking order theory
Pecking order theory suggest: that firm should exhaust their internal fund before resorting to external financing
These result suggest that firm that resort to external resources for funds attempt to first exhaust their internal funds by paying lower dividend
Dividend policy and firm size
“There is a positive correlation between size and dividend policy”, logic think that firm size may serve as a proxy for asymmetric information where larger firm have less asymmetric information
Dividend policy, Asymmetric information, and issue cost
CONCLUSSION
àConssitent with pecking order theory:
· The positive relation between dividend and analyst
· Positive relation between dividend and cash flow and the negative realtion between dividend and growth opportunities
This paper provideà direct evidence à even though the implications of the pecking order theory for dividend policy are often discussed.
SHARE REPURCHASE:
SHARE REPURCHASE:
TO BUY OR NOT TO BUY
INTRRODUCTION
àThere are growing surge of buyback
à There are four key finding:
1. 39% in order to improve their earnigs per share numbers.
2. 28% as away to distribute excess cash to share holders.
3. 21% as trying to reduce the cost of employees’ stock eption plans.
4. 12% noted that adjusting capital structure was the main reson for their stock buyback
--. The mission; to determine the long-term effect of stock buyback programs on a company’s stock price and to access which company benefit most from these programà. Published in the study: the share repurchases decisioi : causes consequences and implementation gidelines
WHY REPURCHSE SHARE
à Commonly there are 5 reasons:
To increase share repurchase
To reationally the company’s capital structure.
To subtitute share repurchases for cash dividend payout
To prevent dilution of earnings.to deploy excess cash flow.
à To repurchase there several optionsà open markets repurchaese, privately negotiated repurchases, private negotiation à research use open market
à Data: 48% use company with caps $200 million, 10% that Use Company inexess $10 billionà that use 37 different industries
FOUR KEY FINDING
Shares outstanding
no substitute for dividend payout
Effect on earning per share
Effect on debt
GUIDELINES FOR GETTIGN GOING
à Recommended for company for repurchases equity, when:
when they have excess debt capacity, and the supply of funds exceed the demand
when they are under performing,in terms of profitable and sales, relative to their industry average
à When avoid buyback:
When they’re over-leveraged and sales growth exceed industry average
when both their profitability and sales growth rates exceed industry averages
THE VALUE CONNECTION
à One key to understand the complexeffect6 of share repurchases program on a company’s profitability is the Shareholder Volder Based Management Framework (SVBM frameqork
)
TO BUY OR NOT TO BUY
INTRRODUCTION
àThere are growing surge of buyback
à There are four key finding:
1. 39% in order to improve their earnigs per share numbers.
2. 28% as away to distribute excess cash to share holders.
3. 21% as trying to reduce the cost of employees’ stock eption plans.
4. 12% noted that adjusting capital structure was the main reson for their stock buyback
--. The mission; to determine the long-term effect of stock buyback programs on a company’s stock price and to access which company benefit most from these programà. Published in the study: the share repurchases decisioi : causes consequences and implementation gidelines
WHY REPURCHSE SHARE
à Commonly there are 5 reasons:
To increase share repurchase
To reationally the company’s capital structure.
To subtitute share repurchases for cash dividend payout
To prevent dilution of earnings.to deploy excess cash flow.
à To repurchase there several optionsà open markets repurchaese, privately negotiated repurchases, private negotiation à research use open market
à Data: 48% use company with caps $200 million, 10% that Use Company inexess $10 billionà that use 37 different industries
FOUR KEY FINDING
Shares outstanding
no substitute for dividend payout
Effect on earning per share
Effect on debt
GUIDELINES FOR GETTIGN GOING
à Recommended for company for repurchases equity, when:
when they have excess debt capacity, and the supply of funds exceed the demand
when they are under performing,in terms of profitable and sales, relative to their industry average
à When avoid buyback:
When they’re over-leveraged and sales growth exceed industry average
when both their profitability and sales growth rates exceed industry averages
THE VALUE CONNECTION
à One key to understand the complexeffect6 of share repurchases program on a company’s profitability is the Shareholder Volder Based Management Framework (SVBM frameqork
)
Selasa, 01 April 2008
THE FINANCING OF PRIVATE ENTERPRISE IN CHINA
THE FINANCING OF PRIVATE ENTERPRISE IN CHINA
Neil Gregory and stoyan tenev.
“A 1999 survey of more than 600 private Chinese enterprises revealed that they relied primarily on self-financing. For china’s private sector to thrive, firm will need increased access to external loan ad equity financing”
INTRODUCTION
Ø Enterprises play a strong ruleà in 1998 had grown about 27% of GDP à end 1999 the private sector accounted only 1% of bank lendingà only 1% listed in SSX
FINANCING PATTERN
Ø Survey by International Finance corporation (IFC )1999: Beijing, Chengd, Shunde (Guangdong), and wengzhou (Zhengjang)
o 80% lack of access to financeà seriously constrainàrelied o self financing for both start-up and expansion
o 90% their initial capital came from their principal owners, the start-up team and the families
o 62% of financing coming from the principal owners or out of retained earning
o External source for the smallest firm are mainly informal channels
o On average, Chinese bank tend to play a relatively small role in financing private firmà only 29% of surveyed fir had secured loans I the previous five years
FACTOR AFFECTING ACCESS TO FINANCING
“Basically there two difficulty, partly to factors within the financial system, and partly to the nature of Chinese private enterprises”
Factors:
Ø Bank Incentive
“Local government continue to encourage bank lending to state-owned enterprise by extending explicit or implicit guarantees or through other meansà bank will discriminate against private sector firm”
Ø Bank procedure
“the procedure, both formal and non-formal, rely on collateral and personal relationship rather than on the project appraisal”
Still debatable, because we know that china today still exist become a dragon in Asia, even though they still use method like thatà look at behavioral finance.
Ø Collateral requirement
Inability to meet collateral requirements
Ø Information problem
POLICY AGENDA FOR FINANCING SECTOR
Ø Strengthen bank’s incentive to lend to private enterprises
Ø Further liberalized interest rates
Ø Allows bank to charge transaction fees
Ø Develop alternatives to bank lending, such as leasing and factoring
Ø Create a framework for the development of private equity
Ø Improve access to public equity
CONCLUSSION
Improving financing accessàneed changes in enterprises themselvesàwith the greater access to external finance, China’s private enterprises will continue to play a larger role in the growth and transformation on the Chinese economy
Neil Gregory and stoyan tenev.
“A 1999 survey of more than 600 private Chinese enterprises revealed that they relied primarily on self-financing. For china’s private sector to thrive, firm will need increased access to external loan ad equity financing”
INTRODUCTION
Ø Enterprises play a strong ruleà in 1998 had grown about 27% of GDP à end 1999 the private sector accounted only 1% of bank lendingà only 1% listed in SSX
FINANCING PATTERN
Ø Survey by International Finance corporation (IFC )1999: Beijing, Chengd, Shunde (Guangdong), and wengzhou (Zhengjang)
o 80% lack of access to financeà seriously constrainàrelied o self financing for both start-up and expansion
o 90% their initial capital came from their principal owners, the start-up team and the families
o 62% of financing coming from the principal owners or out of retained earning
o External source for the smallest firm are mainly informal channels
o On average, Chinese bank tend to play a relatively small role in financing private firmà only 29% of surveyed fir had secured loans I the previous five years
FACTOR AFFECTING ACCESS TO FINANCING
“Basically there two difficulty, partly to factors within the financial system, and partly to the nature of Chinese private enterprises”
Factors:
Ø Bank Incentive
“Local government continue to encourage bank lending to state-owned enterprise by extending explicit or implicit guarantees or through other meansà bank will discriminate against private sector firm”
Ø Bank procedure
“the procedure, both formal and non-formal, rely on collateral and personal relationship rather than on the project appraisal”
Still debatable, because we know that china today still exist become a dragon in Asia, even though they still use method like thatà look at behavioral finance.
Ø Collateral requirement
Inability to meet collateral requirements
Ø Information problem
POLICY AGENDA FOR FINANCING SECTOR
Ø Strengthen bank’s incentive to lend to private enterprises
Ø Further liberalized interest rates
Ø Allows bank to charge transaction fees
Ø Develop alternatives to bank lending, such as leasing and factoring
Ø Create a framework for the development of private equity
Ø Improve access to public equity
CONCLUSSION
Improving financing accessàneed changes in enterprises themselvesàwith the greater access to external finance, China’s private enterprises will continue to play a larger role in the growth and transformation on the Chinese economy
PECKING ORDER or TRADE OFF HYPOTHESIS? EVIDENCE ON THE CAPITAL STUCTURE OF CINESE COMPANIES
PECKING ORDER or TRADE OFF HYPOTHESIS? EVIDENCE ON THE CAPITAL STUCTURE OF CINESE COMPANIES
INTRODUCTION
Ø How capital structure determine? There are two broad competing model:
àTrade-off theory: state value maximizing fir will pursue an optimal capital structure by consider marginal cost and benefit of each additional unit of financing and then choosing form of financing that equates these marginal cost and benefit
à Pecking order theory: based on the argument that asymmetric information creates a hierarchy of cost in the use of external financing which is broadly common to all firm.
“There is no unique optimal capital structure to which a firm, gravitates n the long run”
Ø There is conceptual differences between two theory and distinguish between two in practice is not easy.;
Fama and Frech (2002)à trade-off did better in one case, pecking order in the other.
Graham and Harvey (2001)à there was a little evidence that a asymmetric information was a factor in financial decision.
Prasad et al (2001a)à the evidence remain inconclusive
Ø Singh and Hamid (1992) and Singh (1995), determine that firm in developing economies rely more heavily on equity than on debt to finance growth than do their counterpart in the industrial economies
“It is difficult to distinguish between trade-off and pecking order models because many determining variables are relevant in both models.
Ø This paperà sample listed Chinese company àlimited to a cross section of China’s top 50 listed companies in 2002 à using data for 2002 and then for 2003 (although a small sample may attenuate the generality of the result compare with the finding of Huan and Song (2002) with their larger but earlier dataset)
Ø Reason why Chinese company:
o Almost unique position being both a developing and transition economy
o Most listed companies were formerly owned by the state.
HYPOTHESES
Fama and French (2002)à Many variables held to determine leverage are common to both theoryà difficult to ‘horse race’ between two regression to distinguish adequately between two theory à have very different implication for corporate behavior.
Ø Determinant of leverage: profitability, size and growth
Trade-off theory predict a positive relationship between leverage and profitability
Suggest a positive relationship between leverage and fir size
Suggest a negative relationship between leverage and growth rate
Pecking order, there will be a negative relationship between leverage and profitability
Suggest a negative relationship between leverage and firm size
Suggest a positive relationship between leverage and growth rate
Ø Leverage and dividend
Trade-off theory implying a negative or significant relationship between dividend and leverage
Pecking order concludes that a significant positive relationship between the past dividend rate and current leverage
Ø Corporate investment and financing
Trade-off theoryà investment negative relationship to dividend rateà profitability, size and past leverage in the model
Pecking orderànegative relation between investment and sizeà leverage should be negatively related to investment
DATA AND METHODOLOGY
Ø Why china??
o Transition from planned economy to market economy
o Continues to be characteristic by: fragmented capital market, fragile banking system, poorly specified property right and institutional uncertainly
o Relatively short operating history
o Have not accumulate much reputation
o Most listed companies were originally state-owned enterprises, and privatization
o Well-functioning and fully enforced accounting and auditing system has developed only gradually in China.
Ø Data + Methodology:
o China’s top 50 companies for the period 2001-2003
o Data were extracted from published account of non-financial companies listed on the Shanghai and Shenzen stock exchange
o 44 non-financial companies, 15 companies is manufacturing, and the rest in non-manufacturing
o Use two dataset: for 2002 and 2001 using 2002 annual report, for 2003 and 2002 using 2003 annual report à Cross-section regression for 2002 and 2003 were estimated separately.
o Variables used in the regressionà look at the table.1***
Other variables in the model mostly defined in the standard model, there two components:
à Measuring profitability (ROA)
à Dividend (DIVEQ)
o Descriptive statistic are shown in table 2
RESULT
**all state in article is a result**
CONCLUSSION
There are four main finding:
significant negative correlation between leverage and profitability
Significant positive correlation between current leverage and past dividend, although at a lower significant level
the investment model is found between the growth of investment and the rate of past dividend
there is some degree of stability in the parameter values as between 2002 and 2003, notwithstanding the accounting changes which took place between these two years
ACKNOWLEDGE
INTRODUCTION
Ø How capital structure determine? There are two broad competing model:
àTrade-off theory: state value maximizing fir will pursue an optimal capital structure by consider marginal cost and benefit of each additional unit of financing and then choosing form of financing that equates these marginal cost and benefit
à Pecking order theory: based on the argument that asymmetric information creates a hierarchy of cost in the use of external financing which is broadly common to all firm.
“There is no unique optimal capital structure to which a firm, gravitates n the long run”
Ø There is conceptual differences between two theory and distinguish between two in practice is not easy.;
Fama and Frech (2002)à trade-off did better in one case, pecking order in the other.
Graham and Harvey (2001)à there was a little evidence that a asymmetric information was a factor in financial decision.
Prasad et al (2001a)à the evidence remain inconclusive
Ø Singh and Hamid (1992) and Singh (1995), determine that firm in developing economies rely more heavily on equity than on debt to finance growth than do their counterpart in the industrial economies
“It is difficult to distinguish between trade-off and pecking order models because many determining variables are relevant in both models.
Ø This paperà sample listed Chinese company àlimited to a cross section of China’s top 50 listed companies in 2002 à using data for 2002 and then for 2003 (although a small sample may attenuate the generality of the result compare with the finding of Huan and Song (2002) with their larger but earlier dataset)
Ø Reason why Chinese company:
o Almost unique position being both a developing and transition economy
o Most listed companies were formerly owned by the state.
HYPOTHESES
Fama and French (2002)à Many variables held to determine leverage are common to both theoryà difficult to ‘horse race’ between two regression to distinguish adequately between two theory à have very different implication for corporate behavior.
Ø Determinant of leverage: profitability, size and growth
Trade-off theory predict a positive relationship between leverage and profitability
Suggest a positive relationship between leverage and fir size
Suggest a negative relationship between leverage and growth rate
Pecking order, there will be a negative relationship between leverage and profitability
Suggest a negative relationship between leverage and firm size
Suggest a positive relationship between leverage and growth rate
Ø Leverage and dividend
Trade-off theory implying a negative or significant relationship between dividend and leverage
Pecking order concludes that a significant positive relationship between the past dividend rate and current leverage
Ø Corporate investment and financing
Trade-off theoryà investment negative relationship to dividend rateà profitability, size and past leverage in the model
Pecking orderànegative relation between investment and sizeà leverage should be negatively related to investment
DATA AND METHODOLOGY
Ø Why china??
o Transition from planned economy to market economy
o Continues to be characteristic by: fragmented capital market, fragile banking system, poorly specified property right and institutional uncertainly
o Relatively short operating history
o Have not accumulate much reputation
o Most listed companies were originally state-owned enterprises, and privatization
o Well-functioning and fully enforced accounting and auditing system has developed only gradually in China.
Ø Data + Methodology:
o China’s top 50 companies for the period 2001-2003
o Data were extracted from published account of non-financial companies listed on the Shanghai and Shenzen stock exchange
o 44 non-financial companies, 15 companies is manufacturing, and the rest in non-manufacturing
o Use two dataset: for 2002 and 2001 using 2002 annual report, for 2003 and 2002 using 2003 annual report à Cross-section regression for 2002 and 2003 were estimated separately.
o Variables used in the regressionà look at the table.1***
Other variables in the model mostly defined in the standard model, there two components:
à Measuring profitability (ROA)
à Dividend (DIVEQ)
o Descriptive statistic are shown in table 2
RESULT
**all state in article is a result**
CONCLUSSION
There are four main finding:
significant negative correlation between leverage and profitability
Significant positive correlation between current leverage and past dividend, although at a lower significant level
the investment model is found between the growth of investment and the rate of past dividend
there is some degree of stability in the parameter values as between 2002 and 2003, notwithstanding the accounting changes which took place between these two years
ACKNOWLEDGE
Education in Regulation (article)
Education in Regulation
Cory Levine. Wall Street & Technology. New York: Apr 2006. pg. 21, 2 pgs
Abstract (Summary)
In partnership with the NASD, the University of Reading will offer what is believed to be a first-of-its-kind Master's in Capital Markets, Regulation and Compliance beginning in October. The program will be taught at the ICMA Centre, the University's business school, in Reading, England. The master's program will be a 10-month curriculum designed to provide students with a basis of the conceptual knowledge and principles to face the challenges of both creating regulation and ensuring compliance for the capital markets. Students will learn the ins and outs of market structure, investment products and asset classes, risk assessment, theory of regulation and compliance, practical application, management, and law. For a profession that has been an unstructured conglomerate of law and finance, formal training in the form of an accredited master's degree may bring a sense of legitimacy to a discipline that until recently has gone largely overlooked.
» Jump to indexing (document details)
Full Text (1335 words)
Copyright CMP Media LLC Apr 2006
[Headnote]
A new master's degree program seeks to ease regulatory burdens with an influx of highly educated compliance professionals. By Cory Levine
HAVE YOU EVER seen a child spend a Saturday afternoon practicing filing audit reports or cataloging archived e-mails? While no child ever says he wants to be a market regulator or a compliance officer when he grows up, a new master's degree program from the University of Reading (U.K.) aims to make that option available and bring an influx of trained compliance professionals into the securities industry.
In partnership with the National Association of securities Dealers (NASD), the University of Reading will offer what is believed to be a first-of-its-kind Master's in Capital Markets, Regulation and Compliance beginning in October. The program will be taught at the ICMA Centre, the University's business school, in Reading, England.
Increasingly complex investment products and market strategies have led to numerous equally complex regulations designed to protect investors and maintain market integrity. Faced with sweeping market reform mandates from regulatory bodies across the globe, maintaining a compliance staff with the ability and training to facilitate mandated changes without sacrificing margins is top of mind for financial institutions. Consequently, this has created a demand for human capital in the fields of regulation and compliance.
Traditionally, people in the compliance profession have come from varied backgrounds, often some combination of finance and law. But there has never before been a program designed specifically to provide a degree in compliance and regulation in the capital markets as its own discipline, according to the NASD and the University of Reading.
Enlarge 200%
Enlarge 400%
[Photograph]
The NASD and the University of Reading hope the new program will facilitate an industrywide strengthening of compliance efforts by training professionals with a robust understanding of the markets and the principles of applicable mandates. "We think that this program will really focus people on these issues, not only because they have to as a practical matter, but because there is a rigor and a discipline around it now that's never been there before," says Paul Andrews, VP and deputy managing director of international affairs and services for the NASD.
Meeting Industry Demand
The need for more physical bodies to meet the demands of market regulations is obvious. Stateside, Regulation National Market Structure (Reg NMS) is keeping executives awake at night, while in the European Union, implementation of the Markets in Financial Instruments Directive (MiFID) is a top priority for financial institutions.
According to the 2006 Market Report in compliance from Barclay Simpson, a London-based recruitment firm, new job vacancies in U.K.-based compliance offices more than doubled during 2005. In the first quarter of 2005, London-based Barclay Simpson reported 27 new openings in the compliance field listed with the firm, a number that grew steadily throughout the year to 60 open positions by the fourth quarter.
"This has come about through some meetings that we were conducting in London with major investment banks ... about education and training needs," says Andrews. "Compliance issues have risen to the top of the barrel."
These businesses' concerns over market regulation certainly are warranted, since even the most seemingly insignificant mandate can have a considerable impact on operations and processes. The complexity of financial markets and financial institutions, particularly those operating globally, makes implementing even minor changes a major undertaking. Bring into play the industry-altering changes required by initiatives such as Reg NMS, and compliance becomes perhaps the most daunting of all business challenges.
Sources of advanced training and education in compliance such as the University of Reading's master's degree program are imperative, according to Lauren Bender, a senior analyst in Celent's securities and investments practice who is based in Paris. "It can't be learned on the job anymore" she asserts. And, "It can't be learned at one company." The changing face of global industry has made domestic and international compliance an integral aspect of running a business in the securities industry, and it is now beginning to be treated as such. "Compliance has a big impact on costs and on margin," Bender continues. "So I think this program is recognition of a new reality."
Setting the Course
The master's program will be a 10-month curriculum designed to provide students with a basis of the conceptual knowledge and principles to face the challenges of both creating regulation and ensuring compliance for the capital markets. Students will learn the ins and outs of market structure, investment products and asset classes, risk assessment, theory of regulation and compliance, practical application, management, and law, according to John Board, professor of finance and director of the ICMA Centre.
The training, however, is not meant to replace on-the-job experience, stresses Board. "We're not trying to create fully formed compliance officers," he says. Rather, the focus of the program will be to provide a broad background in preparation for a career, "not minutiae of individual regulations," Board adds.
The investment banking community is supporting the NASD and the University of Reading in the effort. The academic curriculum will be developed in conference with major banks, including Deutsche Bank, HSBC, JPMorgan Chase and Merrill Lynch. Representatives from these firms will act as a "steering committee," Board relates. The firms will ensure that the curriculum will meet the future demands of the global regulatory and compliance environment, he explains. Additionally, several of these organizations will volunteer internship programs to students pursuing the master's degree, affording the scholars practical experience and giving the businesses a chance to evaluate the program's products, Board notes.
Celent's Bender argues that the most important skill a student can learn from the degree program is to understand the subtleties of creating and maintaining an effective compliance office within an organization. "It's really going to require [a familiarity] with technology and systems, with strategy and with marketing," she says. "Internally, in order to comply, you touch a lot of people's worlds. You step across people's turf in different ways."
Understanding and managing the complex relationships among a business' compliance office and the rest of the organization is what separates the highly qualified from the merely mediocre, Bender asserts. It will be that principle that is most important to the success of the program's graduates, she believes.
For a profession that has been an unstructured conglomerate of law and finance, formal training in the form of an accredited master's degree may bring a sense of legitimacy to a discipline that until recently has gone largely overlooked. The demand for the University of Reading's program, and the securities community's participation, indicates that firms are looking to their compliance offices as an organizational entity with a competitive impact.
'A Strategic Differentiator'
"Compliance can actually be a strategic differentiator," says Bender. If you can do it better, cheaper and faster, "There's a strategic advantage to using compliance, even though you have to anyway," she adds.
The University of Reading's board agrees that people will be looking to the compliance office for a competitive leg up, and will recruit and staff accordingly. "The sense that everybody in London has is that in five years' time, compliance will be a functional profession," Board says. Businesses will look for talented compliance officers, rather than skilled lawyers who just so happen to practice financial law, he suggests.
The NASD already is looking to partner with universities in other regions for similar programs, according to the organization's Andrews. In the short term, programs in Latin America and East Asia are under consideration, with the Indian subcontinent also being contemplated, he relates.
But it will be some time before the industry and academic institutions can judge the impact of the University of Reading's master's program accurately, Celent's Bender points out. "The success of this type of degree is really dependent on the graduates - so it's important who they attract and how they do when they get out. The success of the graduates will drive the importance of the degrees."
[Sidebar]
Compliance oversight "can't be learned on the job anymore, [and] it can't be learned at one company."
- LAUREN BENDER, Celent
Cory Levine. Wall Street & Technology. New York: Apr 2006. pg. 21, 2 pgs
Abstract (Summary)
In partnership with the NASD, the University of Reading will offer what is believed to be a first-of-its-kind Master's in Capital Markets, Regulation and Compliance beginning in October. The program will be taught at the ICMA Centre, the University's business school, in Reading, England. The master's program will be a 10-month curriculum designed to provide students with a basis of the conceptual knowledge and principles to face the challenges of both creating regulation and ensuring compliance for the capital markets. Students will learn the ins and outs of market structure, investment products and asset classes, risk assessment, theory of regulation and compliance, practical application, management, and law. For a profession that has been an unstructured conglomerate of law and finance, formal training in the form of an accredited master's degree may bring a sense of legitimacy to a discipline that until recently has gone largely overlooked.
» Jump to indexing (document details)
Full Text (1335 words)
Copyright CMP Media LLC Apr 2006
[Headnote]
A new master's degree program seeks to ease regulatory burdens with an influx of highly educated compliance professionals. By Cory Levine
HAVE YOU EVER seen a child spend a Saturday afternoon practicing filing audit reports or cataloging archived e-mails? While no child ever says he wants to be a market regulator or a compliance officer when he grows up, a new master's degree program from the University of Reading (U.K.) aims to make that option available and bring an influx of trained compliance professionals into the securities industry.
In partnership with the National Association of securities Dealers (NASD), the University of Reading will offer what is believed to be a first-of-its-kind Master's in Capital Markets, Regulation and Compliance beginning in October. The program will be taught at the ICMA Centre, the University's business school, in Reading, England.
Increasingly complex investment products and market strategies have led to numerous equally complex regulations designed to protect investors and maintain market integrity. Faced with sweeping market reform mandates from regulatory bodies across the globe, maintaining a compliance staff with the ability and training to facilitate mandated changes without sacrificing margins is top of mind for financial institutions. Consequently, this has created a demand for human capital in the fields of regulation and compliance.
Traditionally, people in the compliance profession have come from varied backgrounds, often some combination of finance and law. But there has never before been a program designed specifically to provide a degree in compliance and regulation in the capital markets as its own discipline, according to the NASD and the University of Reading.
Enlarge 200%
Enlarge 400%
[Photograph]
The NASD and the University of Reading hope the new program will facilitate an industrywide strengthening of compliance efforts by training professionals with a robust understanding of the markets and the principles of applicable mandates. "We think that this program will really focus people on these issues, not only because they have to as a practical matter, but because there is a rigor and a discipline around it now that's never been there before," says Paul Andrews, VP and deputy managing director of international affairs and services for the NASD.
Meeting Industry Demand
The need for more physical bodies to meet the demands of market regulations is obvious. Stateside, Regulation National Market Structure (Reg NMS) is keeping executives awake at night, while in the European Union, implementation of the Markets in Financial Instruments Directive (MiFID) is a top priority for financial institutions.
According to the 2006 Market Report in compliance from Barclay Simpson, a London-based recruitment firm, new job vacancies in U.K.-based compliance offices more than doubled during 2005. In the first quarter of 2005, London-based Barclay Simpson reported 27 new openings in the compliance field listed with the firm, a number that grew steadily throughout the year to 60 open positions by the fourth quarter.
"This has come about through some meetings that we were conducting in London with major investment banks ... about education and training needs," says Andrews. "Compliance issues have risen to the top of the barrel."
These businesses' concerns over market regulation certainly are warranted, since even the most seemingly insignificant mandate can have a considerable impact on operations and processes. The complexity of financial markets and financial institutions, particularly those operating globally, makes implementing even minor changes a major undertaking. Bring into play the industry-altering changes required by initiatives such as Reg NMS, and compliance becomes perhaps the most daunting of all business challenges.
Sources of advanced training and education in compliance such as the University of Reading's master's degree program are imperative, according to Lauren Bender, a senior analyst in Celent's securities and investments practice who is based in Paris. "It can't be learned on the job anymore" she asserts. And, "It can't be learned at one company." The changing face of global industry has made domestic and international compliance an integral aspect of running a business in the securities industry, and it is now beginning to be treated as such. "Compliance has a big impact on costs and on margin," Bender continues. "So I think this program is recognition of a new reality."
Setting the Course
The master's program will be a 10-month curriculum designed to provide students with a basis of the conceptual knowledge and principles to face the challenges of both creating regulation and ensuring compliance for the capital markets. Students will learn the ins and outs of market structure, investment products and asset classes, risk assessment, theory of regulation and compliance, practical application, management, and law, according to John Board, professor of finance and director of the ICMA Centre.
The training, however, is not meant to replace on-the-job experience, stresses Board. "We're not trying to create fully formed compliance officers," he says. Rather, the focus of the program will be to provide a broad background in preparation for a career, "not minutiae of individual regulations," Board adds.
The investment banking community is supporting the NASD and the University of Reading in the effort. The academic curriculum will be developed in conference with major banks, including Deutsche Bank, HSBC, JPMorgan Chase and Merrill Lynch. Representatives from these firms will act as a "steering committee," Board relates. The firms will ensure that the curriculum will meet the future demands of the global regulatory and compliance environment, he explains. Additionally, several of these organizations will volunteer internship programs to students pursuing the master's degree, affording the scholars practical experience and giving the businesses a chance to evaluate the program's products, Board notes.
Celent's Bender argues that the most important skill a student can learn from the degree program is to understand the subtleties of creating and maintaining an effective compliance office within an organization. "It's really going to require [a familiarity] with technology and systems, with strategy and with marketing," she says. "Internally, in order to comply, you touch a lot of people's worlds. You step across people's turf in different ways."
Understanding and managing the complex relationships among a business' compliance office and the rest of the organization is what separates the highly qualified from the merely mediocre, Bender asserts. It will be that principle that is most important to the success of the program's graduates, she believes.
For a profession that has been an unstructured conglomerate of law and finance, formal training in the form of an accredited master's degree may bring a sense of legitimacy to a discipline that until recently has gone largely overlooked. The demand for the University of Reading's program, and the securities community's participation, indicates that firms are looking to their compliance offices as an organizational entity with a competitive impact.
'A Strategic Differentiator'
"Compliance can actually be a strategic differentiator," says Bender. If you can do it better, cheaper and faster, "There's a strategic advantage to using compliance, even though you have to anyway," she adds.
The University of Reading's board agrees that people will be looking to the compliance office for a competitive leg up, and will recruit and staff accordingly. "The sense that everybody in London has is that in five years' time, compliance will be a functional profession," Board says. Businesses will look for talented compliance officers, rather than skilled lawyers who just so happen to practice financial law, he suggests.
The NASD already is looking to partner with universities in other regions for similar programs, according to the organization's Andrews. In the short term, programs in Latin America and East Asia are under consideration, with the Indian subcontinent also being contemplated, he relates.
But it will be some time before the industry and academic institutions can judge the impact of the University of Reading's master's program accurately, Celent's Bender points out. "The success of this type of degree is really dependent on the graduates - so it's important who they attract and how they do when they get out. The success of the graduates will drive the importance of the degrees."
[Sidebar]
Compliance oversight "can't be learned on the job anymore, [and] it can't be learned at one company."
- LAUREN BENDER, Celent
EDUCATION IN REGULATION (job article)
à the University of Reading will offer what is believed to be a first-of-its-kind Master's in Capital Markets:
ins and outs of market structure,
investment products and asset classes,
risk assessment,
theory of regulation and compliance,
Practical application, management, and law.
à Increasingly complex investment products and market strategies have led to numerous equally complex regulations designed to protect investors and maintain market integrity consequently, this has created a demand for human capital in the fields of regulation and compliance.
Setting the Course
· 10-month curriculum
· The investment banking community is supporting the NASD and the University of Reading in the effort.
'A Strategic Differentiator'
· Compliance can actually be a strategic differentiator WITH faster and cheaper
ins and outs of market structure,
investment products and asset classes,
risk assessment,
theory of regulation and compliance,
Practical application, management, and law.
à Increasingly complex investment products and market strategies have led to numerous equally complex regulations designed to protect investors and maintain market integrity consequently, this has created a demand for human capital in the fields of regulation and compliance.
Setting the Course
· 10-month curriculum
· The investment banking community is supporting the NASD and the University of Reading in the effort.
'A Strategic Differentiator'
· Compliance can actually be a strategic differentiator WITH faster and cheaper
Senin, 24 Maret 2008
CRASH COURSE IN... SETTING THE BUDGET (job)
Here are some of the things you should do:
1. Do not panic.
budget is not rocket science, says Chris Jackson. Basically difficult to know what is the rocket science, but when we see from psychology point of view, we can know that the main poin is we have to use health mind, when we face the problem especially when setting the budget
2. Put strategy first.
The plan flows from the strategy, which is broken down to goals and targets for each bit of the business.
3. Forget last year.
'You need to be continually questioning the shape of the business,
4. Devolve and challenge
If you want people to meet their budget, they need to have ownership. Every manager should ask all those who spend money how much they need, and to justify it. You'll end up with departmental and company budgets that everyone has signed up to.
Another think that we have to consider is (mind set about the budgeting)
Size doesn't matter
Think downside
Keep on checking
1. Do not panic.
budget is not rocket science, says Chris Jackson. Basically difficult to know what is the rocket science, but when we see from psychology point of view, we can know that the main poin is we have to use health mind, when we face the problem especially when setting the budget
2. Put strategy first.
The plan flows from the strategy, which is broken down to goals and targets for each bit of the business.
3. Forget last year.
'You need to be continually questioning the shape of the business,
4. Devolve and challenge
If you want people to meet their budget, they need to have ownership. Every manager should ask all those who spend money how much they need, and to justify it. You'll end up with departmental and company budgets that everyone has signed up to.
Another think that we have to consider is (mind set about the budgeting)
Size doesn't matter
Think downside
Keep on checking
CRASH COURSE IN... SETTING THE BUDGET
Abstract (Summary)
The FD tells you that operational spending was 20% over budget last year and capital expenditure went through the roof. But there has been a splurge on office carpets and sofas lately as departments resolve to use it rather than lose it. And as the bean-counters set about next year's figures, there is a line of Oliver Twists outside your door. Here are some of the things you should do: 1. Do not panic. 2. Put strategy first. 3. Forget last year. 4. Devolve and challenge.
» Jump to indexing (document details)
Full Text (484 words)
Copyright Haymarket Business Publications Ltd. Apr 2007
[Headnote]
The FD tells you that operational spending was 20% over budget last year and capital expenditure went through the roof. But there's been a splurge on office carpets and sofas lately as departments resolve to use it rather than lose it. And as the bean-counters set about next year's figures, there's a line of Oliver Twists outside your door. What to do?
Don't panic. Setting a budget is not rocket science, says Chris Jackson, head of the finance and management faculty at the Institute of Chartered Accountants. 'It's really just putting numbers to a business plan.'
Put strategy first. The plan flows from the strategy, which is broken down to goals and targets for each bit of the business. 'You should brainstorm the optimal way to meet your objectives without attaching any pound notes to begin with,' says accountant and trainer Anne Hawkins (www.leanmeansbeans.com). 'If you put the money first, you miss a huge chance for blue-sky thinking.'
Forget last year. It might be a useful reference point, but cutting the pie in the same proportions each year is a recipe tor maintaining the status quo. 'You need to be continually questioning the shape of the business,' says Hawkins.
Devolve and challenge. If you want people to meet their budget, they need to have ownership. Every manager should ask all those who spend money how much they need, and to justify it. You'll end up with departmental and company budgets that everyone has signed up to.
Raise the bar. Budgets are about setting stretch targets as well as allocating resources, says Jackson. 'It's down to the judgment of management to reconcile the tension between what's ambitious and what's realistic.'
Size doesn't matter. Too often, the bigger your budget, the more important you are. Promote a cultural shift so that brownie points are gained for doing more with less. 'You want everyone to think about the best way to allocate resources rather than getting the biggest slice,' says Hawkins.
Think downside. Risk analysis should go hand-in-hand with budget management. Every department should state the assumptions on which their bid is made, and consider threats and opportunities. 'The more transparency and clarity the better,' says Jackson. Building contingency into the budget is line, but ensure it's done consistently; don't add a margin at every layer.
Keep on checking. A budget is not to be put away in a drawer tor 12 months. Review where you are against the budget as regularly as possible, and take prompt action to reset budgets and reallocate resources when you need to. Effective budget management helps an organisation to meet its strategic objectives without a financial crisis.
Do say: "Let's look at how we can improve on last year's performance while freeing funding for other parts of the business.'
Don't say: 'Anyone in this department who hasn't spent every penny of their budget by April 5 will be shot.'
Alexander Garrett
The FD tells you that operational spending was 20% over budget last year and capital expenditure went through the roof. But there has been a splurge on office carpets and sofas lately as departments resolve to use it rather than lose it. And as the bean-counters set about next year's figures, there is a line of Oliver Twists outside your door. Here are some of the things you should do: 1. Do not panic. 2. Put strategy first. 3. Forget last year. 4. Devolve and challenge.
» Jump to indexing (document details)
Full Text (484 words)
Copyright Haymarket Business Publications Ltd. Apr 2007
[Headnote]
The FD tells you that operational spending was 20% over budget last year and capital expenditure went through the roof. But there's been a splurge on office carpets and sofas lately as departments resolve to use it rather than lose it. And as the bean-counters set about next year's figures, there's a line of Oliver Twists outside your door. What to do?
Don't panic. Setting a budget is not rocket science, says Chris Jackson, head of the finance and management faculty at the Institute of Chartered Accountants. 'It's really just putting numbers to a business plan.'
Put strategy first. The plan flows from the strategy, which is broken down to goals and targets for each bit of the business. 'You should brainstorm the optimal way to meet your objectives without attaching any pound notes to begin with,' says accountant and trainer Anne Hawkins (www.leanmeansbeans.com). 'If you put the money first, you miss a huge chance for blue-sky thinking.'
Forget last year. It might be a useful reference point, but cutting the pie in the same proportions each year is a recipe tor maintaining the status quo. 'You need to be continually questioning the shape of the business,' says Hawkins.
Devolve and challenge. If you want people to meet their budget, they need to have ownership. Every manager should ask all those who spend money how much they need, and to justify it. You'll end up with departmental and company budgets that everyone has signed up to.
Raise the bar. Budgets are about setting stretch targets as well as allocating resources, says Jackson. 'It's down to the judgment of management to reconcile the tension between what's ambitious and what's realistic.'
Size doesn't matter. Too often, the bigger your budget, the more important you are. Promote a cultural shift so that brownie points are gained for doing more with less. 'You want everyone to think about the best way to allocate resources rather than getting the biggest slice,' says Hawkins.
Think downside. Risk analysis should go hand-in-hand with budget management. Every department should state the assumptions on which their bid is made, and consider threats and opportunities. 'The more transparency and clarity the better,' says Jackson. Building contingency into the budget is line, but ensure it's done consistently; don't add a margin at every layer.
Keep on checking. A budget is not to be put away in a drawer tor 12 months. Review where you are against the budget as regularly as possible, and take prompt action to reset budgets and reallocate resources when you need to. Effective budget management helps an organisation to meet its strategic objectives without a financial crisis.
Do say: "Let's look at how we can improve on last year's performance while freeing funding for other parts of the business.'
Don't say: 'Anyone in this department who hasn't spent every penny of their budget by April 5 will be shot.'
Alexander Garrett
TIE YOUR CAPITAL BUDGET TO YOUR STRATEGIC PLAN
TIE YOUR CAPITAL BUDGET TO YOUR STRATEGIC PLAN
INTRODUCTION
“Commonly the managers just concern about their responsible, they hadn’t considered what might happen with the capital budget to the strategic plan”
Capital assets decision are the most irrevocable long-range activities
But the irony is this decision process has become one of management’s most mechanical activities
DEFINING THE STRATEGIC PLAN
The strategic plan must be a living document
“The product is the plan; the written document is the interaction that takes place among the employees and management to develop the plan”
Focus first to the customers,à then on the business’s capabilities to meet those needs with its product and service
Operating mangersà makes plan happen
Staff mangers are à supporting
BUILDING THE PLAN
Begins with the a corporate mission statement
It is identifies; 1. Guidelines for targeting the corporate market
2. Guidelines the corporate organizational features
MANAGING THE ASSETS
As you develop the strategic plan, you’ll need to look at your fixed assetà managing capital assets must be a prime consideration.
There are three stages:
Acquisition (when operating management determine the plant activities are inadequate to support corporate needs for growth or corporate citizenship)
Maintenance (second stage, “if an assets doesn’t have a long-term strategic fit, get rid of it while it still has value”)
Disposition (of assets rarely gets proper attention)
The goal here is to ensure the assets will be fully utilized and support management’s strategic vision.
IS THE PROGRAM EFFECTIVE?
“Identify” is the y point, means that you have to identify the key measurements that will keep the program viable and effective.
THE CAPITAL BUDGETING
There 4 interdependent step:
defining and communicating firm’s long range and strategic plans and goals
developing a system that permits the orderly gathering and ranking of investment proposal
determining the accuracy of the estimates that will be used in the estimated rate of return calculation
determining and assigning level of risk probabilities to each investment proposal
EFFECTICVE IMPLEMENTATION IS KEY
the driving force is its effective implementation
develop strategic plan assumption à merge information to various functional plan and link it to short and long termàconsolidated the data in to corporate plan
“the capital budgeting program provides a foundation for the overall strategic plan”
INTRODUCTION
“Commonly the managers just concern about their responsible, they hadn’t considered what might happen with the capital budget to the strategic plan”
Capital assets decision are the most irrevocable long-range activities
But the irony is this decision process has become one of management’s most mechanical activities
DEFINING THE STRATEGIC PLAN
The strategic plan must be a living document
“The product is the plan; the written document is the interaction that takes place among the employees and management to develop the plan”
Focus first to the customers,à then on the business’s capabilities to meet those needs with its product and service
Operating mangersà makes plan happen
Staff mangers are à supporting
BUILDING THE PLAN
Begins with the a corporate mission statement
It is identifies; 1. Guidelines for targeting the corporate market
2. Guidelines the corporate organizational features
MANAGING THE ASSETS
As you develop the strategic plan, you’ll need to look at your fixed assetà managing capital assets must be a prime consideration.
There are three stages:
Acquisition (when operating management determine the plant activities are inadequate to support corporate needs for growth or corporate citizenship)
Maintenance (second stage, “if an assets doesn’t have a long-term strategic fit, get rid of it while it still has value”)
Disposition (of assets rarely gets proper attention)
The goal here is to ensure the assets will be fully utilized and support management’s strategic vision.
IS THE PROGRAM EFFECTIVE?
“Identify” is the y point, means that you have to identify the key measurements that will keep the program viable and effective.
THE CAPITAL BUDGETING
There 4 interdependent step:
defining and communicating firm’s long range and strategic plans and goals
developing a system that permits the orderly gathering and ranking of investment proposal
determining the accuracy of the estimates that will be used in the estimated rate of return calculation
determining and assigning level of risk probabilities to each investment proposal
EFFECTICVE IMPLEMENTATION IS KEY
the driving force is its effective implementation
develop strategic plan assumption à merge information to various functional plan and link it to short and long termàconsolidated the data in to corporate plan
“the capital budgeting program provides a foundation for the overall strategic plan”
CAPITAL BUDGETING DECISSIONS OF SMALL BUSINESS
CAPITAL BUDGETING DECISSIONS OF SMALL BUSINESS
(Morris G. Danielson and Jonathan A. Scoot)
INTRODUCTION
“This paper analyze the capital budgeting practices of small firm”
· Small firm (≤500 employees)à produces 50% private US GDPà employ 60% of private sector labor force.
· All industries requiring substantial capital investmentàcapital investment in small business also important.
· Several reason (different criteria to evaluate project):
may balance wealth maximization
lack of personnel resources
face capital constrainà making project liquidity a prime concern
· methodology:
ü data collected from NFIB (secondary data)
ü Result include the information about types of investment firm makes (replacement versus expansion)
ü Tools: DCF analysis, payback period (evaluate project), Cash flow projection, Capital budgeting, and tax planning activities (planning), and the last one is use the owner willingness.
· Survey: small and large firm evaluate project differently, lack of sophistication contributes to these result, most class investment is “replacement”, and investment in new product are the most important classes.
· The result in this research, suggest that optimal method of capital budgeting analysis can differ between large and small firm.
I. CAPITAL BUDGETING THEORY and SMALL FIRM
· “Basic theory” Brealey and Myers (2003): “invest in all positive NPV project and reject those with negative NPV” à concern with maximize shareholder wealth à yet small firm often operate in environment that do not satisfy the assumption underlying the basic capital budgeting model.
· Discuss the potential problem in detail and explain why discounted cash flow analysis is not necessarily the one best capital budgeting decision tool for every small firm.
A. Capital budgeting Assumption and the small firm
· Capital Budgeting theoryà primary goalà maximize firm value
· Three :
1. Shareholder wealth maximization may not be the objective of every small firm
2. Many small firms have limited management resources and lack expertise in finance and accounting.
3. Capital market imperfection, which constrain the financing option for small firms.
B. Cash Flow Estimation Issue
“DCF analysis is less valuable when the level of future cash flows is more uncertain”
There are also reasons why a small firm may not use DCF analysisi to evaluate replacement decision.
Small firm do not satisfy the theoryà natural for small firm to evaluate profect using different technique than a larger one.
II. DESCRIPTION of DATA
· Using the survey data
+ Long history in finance literature
- measure mangers belief not their auction
Not be representative the defined population
May misunderstood by some participant
· Data from NFIB in April and May 2003
III. SURVEY RESULT
· Using NFIB survey à address 3 question:
whether the investment and financing activity of small firm conform to the assumption underlying capital budgeting theory
look at the overall planning activities of small firm
provide evidence
· Identify significant differences between average responses.
· Using a multinomial logit to evaluate how the choice of investment evaluation tools is related to a set of firm characteristics.
A. Investment Activity
These results suggest three reasons for a small firm might not to follow the prescription of capital budgeting theory:
1. It is noteworthy that replacement activity is the most important type of investment for almost sample firm.
2. The result suggests that many small firms place internal limits on the amount they will borrow. Thus, many firm cannot separate investment and financing decisions, contrary to capital budgeting theory
3. The results suggest that the personal financial planning considerations of business owners may affect the investment and financial decisions of small firm.
B. Planning Activity
· Many small firm don’t have a formal planning system
· Firm with the highest growth rate are more likely to use each these planning tools
· Newer firm likely to use business plan
· The smallest firm are less likely to make cash flow projections
· Planning activities strongly related to the educational background of the business owners.
C. Project Evaluation Method
· Using gut feel, payback period, the accounting rate of return, DCF (the most theoretically correct method).
· The result is different with (Graham and Harvey (2001)), approximately 75% of their firm evaluate projects using estimates of projects NPV or IRR
· “It is therefore not surprising that their firm use more sophisticated method of project analysis.
D. Multivariate Analysis
· Use the multinomial logit (are represented that affect the decision tools most frequently used to assess the financial viability of a project) to jointly identify factors influencing the choice of a project evaluation tools.
· The result *** see on the paper***
IV. SUMMARY
· Firm with fewer than 250 employees analyze potential investment using much less sophisticated methods than those recommended by capital budgeting theory
· Many small-business owners have limited formal education, and their firm may have incomplete management teams
· Reason: àMany small business do not operate in the perfect capital market that capital budgeting theory assumes
àMany of investment that small firms make cannot easily be evaluated using the DCF techniques recommended by capital budgeting theory
MANY SMALL FIRM FACE CAPITAL BUDGETIGN CHALLENGES THAT DIFFER FROM THOSE FACED BY LARGER FIRMS.
(Morris G. Danielson and Jonathan A. Scoot)
INTRODUCTION
“This paper analyze the capital budgeting practices of small firm”
· Small firm (≤500 employees)à produces 50% private US GDPà employ 60% of private sector labor force.
· All industries requiring substantial capital investmentàcapital investment in small business also important.
· Several reason (different criteria to evaluate project):
may balance wealth maximization
lack of personnel resources
face capital constrainà making project liquidity a prime concern
· methodology:
ü data collected from NFIB (secondary data)
ü Result include the information about types of investment firm makes (replacement versus expansion)
ü Tools: DCF analysis, payback period (evaluate project), Cash flow projection, Capital budgeting, and tax planning activities (planning), and the last one is use the owner willingness.
· Survey: small and large firm evaluate project differently, lack of sophistication contributes to these result, most class investment is “replacement”, and investment in new product are the most important classes.
· The result in this research, suggest that optimal method of capital budgeting analysis can differ between large and small firm.
I. CAPITAL BUDGETING THEORY and SMALL FIRM
· “Basic theory” Brealey and Myers (2003): “invest in all positive NPV project and reject those with negative NPV” à concern with maximize shareholder wealth à yet small firm often operate in environment that do not satisfy the assumption underlying the basic capital budgeting model.
· Discuss the potential problem in detail and explain why discounted cash flow analysis is not necessarily the one best capital budgeting decision tool for every small firm.
A. Capital budgeting Assumption and the small firm
· Capital Budgeting theoryà primary goalà maximize firm value
· Three :
1. Shareholder wealth maximization may not be the objective of every small firm
2. Many small firms have limited management resources and lack expertise in finance and accounting.
3. Capital market imperfection, which constrain the financing option for small firms.
B. Cash Flow Estimation Issue
“DCF analysis is less valuable when the level of future cash flows is more uncertain”
There are also reasons why a small firm may not use DCF analysisi to evaluate replacement decision.
Small firm do not satisfy the theoryà natural for small firm to evaluate profect using different technique than a larger one.
II. DESCRIPTION of DATA
· Using the survey data
+ Long history in finance literature
- measure mangers belief not their auction
Not be representative the defined population
May misunderstood by some participant
· Data from NFIB in April and May 2003
III. SURVEY RESULT
· Using NFIB survey à address 3 question:
whether the investment and financing activity of small firm conform to the assumption underlying capital budgeting theory
look at the overall planning activities of small firm
provide evidence
· Identify significant differences between average responses.
· Using a multinomial logit to evaluate how the choice of investment evaluation tools is related to a set of firm characteristics.
A. Investment Activity
These results suggest three reasons for a small firm might not to follow the prescription of capital budgeting theory:
1. It is noteworthy that replacement activity is the most important type of investment for almost sample firm.
2. The result suggests that many small firms place internal limits on the amount they will borrow. Thus, many firm cannot separate investment and financing decisions, contrary to capital budgeting theory
3. The results suggest that the personal financial planning considerations of business owners may affect the investment and financial decisions of small firm.
B. Planning Activity
· Many small firm don’t have a formal planning system
· Firm with the highest growth rate are more likely to use each these planning tools
· Newer firm likely to use business plan
· The smallest firm are less likely to make cash flow projections
· Planning activities strongly related to the educational background of the business owners.
C. Project Evaluation Method
· Using gut feel, payback period, the accounting rate of return, DCF (the most theoretically correct method).
· The result is different with (Graham and Harvey (2001)), approximately 75% of their firm evaluate projects using estimates of projects NPV or IRR
· “It is therefore not surprising that their firm use more sophisticated method of project analysis.
D. Multivariate Analysis
· Use the multinomial logit (are represented that affect the decision tools most frequently used to assess the financial viability of a project) to jointly identify factors influencing the choice of a project evaluation tools.
· The result *** see on the paper***
IV. SUMMARY
· Firm with fewer than 250 employees analyze potential investment using much less sophisticated methods than those recommended by capital budgeting theory
· Many small-business owners have limited formal education, and their firm may have incomplete management teams
· Reason: àMany small business do not operate in the perfect capital market that capital budgeting theory assumes
àMany of investment that small firms make cannot easily be evaluated using the DCF techniques recommended by capital budgeting theory
MANY SMALL FIRM FACE CAPITAL BUDGETIGN CHALLENGES THAT DIFFER FROM THOSE FACED BY LARGER FIRMS.
Minggu, 16 Maret 2008
Owner compensation (job)
CASE: my own finding article
OWNER COMPENSATION IN THE LAW FIRM
“Increasing competition and a slow economy combined with desire to generate quick increases in partner income create a sharp focus on bottom-line profitability. Behavior contributing to that focus are the ones rewarded”
Law firm must consider their approach to owner compensation. (done with the approval of the managing partner and key senior owners)
They must create new compensation arrangement that fully understanding and always renewing.
The size of the law firm have a influence to the compensation process;
The bigger firm likely to have a formal system of business origination credits
Two-tiered parnertship structures are more prevalent in larger firm than in smaller ones
Larger family firms rely more heavily on compensation committees than do other size firm
OWNER COMPENSATION IN THE LAW FIRM
“Increasing competition and a slow economy combined with desire to generate quick increases in partner income create a sharp focus on bottom-line profitability. Behavior contributing to that focus are the ones rewarded”
Law firm must consider their approach to owner compensation. (done with the approval of the managing partner and key senior owners)
They must create new compensation arrangement that fully understanding and always renewing.
The size of the law firm have a influence to the compensation process;
The bigger firm likely to have a formal system of business origination credits
Two-tiered parnertship structures are more prevalent in larger firm than in smaller ones
Larger family firms rely more heavily on compensation committees than do other size firm
Owner compensation (article)
Owner compensation
Anonymous. Partner's Report. New York: Jun 2003. Vol. 03, Iss. 6; pg. 2
Abstract (Summary)
"These findings reflect what we're [now] seeing in the law firm market," notes [Altman Weil] principal James Cotterman. "Increasing competition and a slow economy combined with a desire to generate quick increases in partner income create a sharp focus on bottom-line profitability. Behaviors contributing to that focus are the ones rewarded."
» Jump to indexing (document details)
Full Text (570 words)
Copyright Institute of Management & Administration Jun 2003
To ensure survival in these rocky economic times, law firms must reconsider their approach to owner compensation. This must be done with the approval of the managing partner and key senior owners. Know, however, that this can take some effort: A partner from one Boston-based firm says the entire partnership met weekly for a long time to shape a compensation plan that all the partners would accept. Key: To minimize damage to firm culture and morale, everyone involved in and affected by the new compensation arrangement must fully understand the implications and be able to explain them.
To thoughtfully assess any changes in your distributions, owners need comprehensive data. One new, reliable source is Altman Weil' s (AW; Newtown Square, Pa.) 2003 Survey of Compensation Systems in Private Law Firms.
How are partner compensation plans evolving? In the AW data ranking of factors that determine compensation, business origination and personal fees collected are at the top; contribution to firm management falls at the midway point; and community involvement, professional involvement (such as writing, speaking, or teaching), and seniority are at the bottom.
"These findings reflect what we're [now] seeing in the law firm market," notes Altman Weil principal James Cotterman. "Increasing competition and a slow economy combined with a desire to generate quick increases in partner income create a sharp focus on bottom-line profitability. Behaviors contributing to that focus are the ones rewarded."
Additional findings from the AW study show significant differences by firm size:
* The bigger the firm, the more likely it is to have a formal system of business-origination credits. Nearly three-quarters (71.9%) of law firms with 100 or more attorneys use formal origination credits in the compensation process, compared to 63.6% of firms with 50 to 99 lawyers and only 40.1% of firms with fewer than 50 attorneys.
"It is obviously easier to have an intuitive understanding of how new business is generated in smaller firms than it is in larger firms," Cotterman explains. "However, it is good to see that many larger firms approach this issue without resorting to formal credit systems."
* Two-tiered partnership structures are more prevalent in larger firms than in smaller ones. According to the data, 65.6% of law firms with 100 or more attorneys prefer this structure, but only 28.1% of smaller firms do. In the lower tier of partnership, overall, 25% of partners make capital contributions to the firm, 27.2% have voting rights when electing senior firm management, and 53.3% share in profits beyond their salary or draw.
* Larger law firms rely more heavily on compensation committees than do other size firms, with 59.4% of firms with 100 or more attorneys having separate committees compared to 45.5% of firms with 50 to 99 attorneys and 18.8% of smaller firms. The most common configuration is to have a separate committee that overlaps the firm's management group. The partners elect committee members in a majority of firms.
[Sidebar]
"Increasing competition and a slow economy combined with a desire to generate quick increases in partner income create a sharp focus on bottom-line profitability.
[Sidebar]
For more information: Altman Weil's 2003 Survey of Compensation Systems in Private Law Firms (call 610-886-2000 for details) is based on data collected from 302 law firms in the fall of 2002. All survey data are reported by firm size and form of organization, including proprietorship, partnership, professional corporation, LLC, and LLP. Source: PR staff
Anonymous. Partner's Report. New York: Jun 2003. Vol. 03, Iss. 6; pg. 2
Abstract (Summary)
"These findings reflect what we're [now] seeing in the law firm market," notes [Altman Weil] principal James Cotterman. "Increasing competition and a slow economy combined with a desire to generate quick increases in partner income create a sharp focus on bottom-line profitability. Behaviors contributing to that focus are the ones rewarded."
» Jump to indexing (document details)
Full Text (570 words)
Copyright Institute of Management & Administration Jun 2003
To ensure survival in these rocky economic times, law firms must reconsider their approach to owner compensation. This must be done with the approval of the managing partner and key senior owners. Know, however, that this can take some effort: A partner from one Boston-based firm says the entire partnership met weekly for a long time to shape a compensation plan that all the partners would accept. Key: To minimize damage to firm culture and morale, everyone involved in and affected by the new compensation arrangement must fully understand the implications and be able to explain them.
To thoughtfully assess any changes in your distributions, owners need comprehensive data. One new, reliable source is Altman Weil' s (AW; Newtown Square, Pa.) 2003 Survey of Compensation Systems in Private Law Firms.
How are partner compensation plans evolving? In the AW data ranking of factors that determine compensation, business origination and personal fees collected are at the top; contribution to firm management falls at the midway point; and community involvement, professional involvement (such as writing, speaking, or teaching), and seniority are at the bottom.
"These findings reflect what we're [now] seeing in the law firm market," notes Altman Weil principal James Cotterman. "Increasing competition and a slow economy combined with a desire to generate quick increases in partner income create a sharp focus on bottom-line profitability. Behaviors contributing to that focus are the ones rewarded."
Additional findings from the AW study show significant differences by firm size:
* The bigger the firm, the more likely it is to have a formal system of business-origination credits. Nearly three-quarters (71.9%) of law firms with 100 or more attorneys use formal origination credits in the compensation process, compared to 63.6% of firms with 50 to 99 lawyers and only 40.1% of firms with fewer than 50 attorneys.
"It is obviously easier to have an intuitive understanding of how new business is generated in smaller firms than it is in larger firms," Cotterman explains. "However, it is good to see that many larger firms approach this issue without resorting to formal credit systems."
* Two-tiered partnership structures are more prevalent in larger firms than in smaller ones. According to the data, 65.6% of law firms with 100 or more attorneys prefer this structure, but only 28.1% of smaller firms do. In the lower tier of partnership, overall, 25% of partners make capital contributions to the firm, 27.2% have voting rights when electing senior firm management, and 53.3% share in profits beyond their salary or draw.
* Larger law firms rely more heavily on compensation committees than do other size firms, with 59.4% of firms with 100 or more attorneys having separate committees compared to 45.5% of firms with 50 to 99 attorneys and 18.8% of smaller firms. The most common configuration is to have a separate committee that overlaps the firm's management group. The partners elect committee members in a majority of firms.
[Sidebar]
"Increasing competition and a slow economy combined with a desire to generate quick increases in partner income create a sharp focus on bottom-line profitability.
[Sidebar]
For more information: Altman Weil's 2003 Survey of Compensation Systems in Private Law Firms (call 610-886-2000 for details) is based on data collected from 302 law firms in the fall of 2002. All survey data are reported by firm size and form of organization, including proprietorship, partnership, professional corporation, LLC, and LLP. Source: PR staff
Discussion of Separation of ownership from Control and Acquiring Firm Performance:
This article provide interesting and important new evidence relevant to the interpretation of the bidder’s abnormal return observed on the announcement date of mergers and acquisition and to the previously documented hypotheses that the separation of control and ownership result in value-destroying mergers and acquisitions as families use takeover to extract private benefits at the expense of minority shareholders.
Theoretical background
àTraditional paradigm in financial economics – agent are fully rational
à Mergers and acquisition are value maximizing decision and that the benefits from such decision should accrue to both the target and the bidder shareholder
à Study based on the long term performance report negative cumulative abnormal return up to 5 years following successful acquisition
à in Canada firm are closely-held mostly by families
à in particular, family ownership mitigates the agency conflicts as families are long-term investor, and thus take a long term view of the firm and they are concerned with the wealth transfer to the next generation.
The data and the methodology
à The Author use the event study methodology to estimate the announcement date abnormal return
Empirical evidence
à use a set of variables to control for the bidder’s ownership structure, the board characteristic, and cross-listing and set of other variables to control for the relative size of the target, its listing and cross-listing statues, the payment method, and for whether the target is in the same industry as the bidder.
àlarger company are likely to have larger boards, suggesting that the non-family companies are likely to be larger than the family firm.
à Family controlled firms are smaller than the controlled firm; they are more likely to rely on internal financing to finance their acquisitions
à Non-family firms are likely to use cash to finance their acquisitions because they can issue equity or bonds
Conclusion
“while the theoretically background on ownership structure is relatively well detailed, I find less argument relating to the various issues detailed in the literature on mergers and acquisition”
Theoretical background
àTraditional paradigm in financial economics – agent are fully rational
à Mergers and acquisition are value maximizing decision and that the benefits from such decision should accrue to both the target and the bidder shareholder
à Study based on the long term performance report negative cumulative abnormal return up to 5 years following successful acquisition
à in Canada firm are closely-held mostly by families
à in particular, family ownership mitigates the agency conflicts as families are long-term investor, and thus take a long term view of the firm and they are concerned with the wealth transfer to the next generation.
The data and the methodology
à The Author use the event study methodology to estimate the announcement date abnormal return
Empirical evidence
à use a set of variables to control for the bidder’s ownership structure, the board characteristic, and cross-listing and set of other variables to control for the relative size of the target, its listing and cross-listing statues, the payment method, and for whether the target is in the same industry as the bidder.
àlarger company are likely to have larger boards, suggesting that the non-family companies are likely to be larger than the family firm.
à Family controlled firms are smaller than the controlled firm; they are more likely to rely on internal financing to finance their acquisitions
à Non-family firms are likely to use cash to finance their acquisitions because they can issue equity or bonds
Conclusion
“while the theoretically background on ownership structure is relatively well detailed, I find less argument relating to the various issues detailed in the literature on mergers and acquisition”
Stakeholders, Governance, and the Russian Enterprise Dilemma
Introduction
Russia problem (economy):
first, the continuing lack of investment and restructuring in the corporate sector
is the “virtual” economy
What happens when manager are owners
àNo external monitoring
àNot limited to protecting minority shareholder or other financiers
owners-managers have to restructure firm and maximize their value over the long run
maximizing value is a reasonable long-term objective only if that value can be realized through the sale of the ownership right in enterprises
because dividend are taxable and have to shared with other stockholder, mainly employees, owners have been more inclined to withdraw cash from their enterprises by requesting reimbursement for fictitious expenses or engaging in other types of theft
Regional government exert influence
àregional governments àceded their power to : regions, regional admnstration
à taxable revenues of firm will have been reduced by cash-flow diversion
Barter and arrears as tools of control
“improved Russian bankruptcy procedures put in pace since 1998 have greatly facilitated the reorganization of insolvent companies”
Russia problem (economy):
first, the continuing lack of investment and restructuring in the corporate sector
is the “virtual” economy
What happens when manager are owners
àNo external monitoring
àNot limited to protecting minority shareholder or other financiers
owners-managers have to restructure firm and maximize their value over the long run
maximizing value is a reasonable long-term objective only if that value can be realized through the sale of the ownership right in enterprises
because dividend are taxable and have to shared with other stockholder, mainly employees, owners have been more inclined to withdraw cash from their enterprises by requesting reimbursement for fictitious expenses or engaging in other types of theft
Regional government exert influence
àregional governments àceded their power to : regions, regional admnstration
à taxable revenues of firm will have been reduced by cash-flow diversion
Barter and arrears as tools of control
“improved Russian bankruptcy procedures put in pace since 1998 have greatly facilitated the reorganization of insolvent companies”
Sabtu, 15 Maret 2008
Chemtura to Review Options, Including Possible Sale(article)
Chemtura says its board has authorized management to consider a wide range of strategic alternatives available to the company to enhance shareholder value. Strategic alternatives to be considered may include, among others, select business divestitures, value-creating acquisitions, changes to the company's capital structure, or a possible sale, merger, or other business combination involving the entire company, Chemtura says. Chemtura announced last April that it would eliminate about 620 jobs, or 10% of its global workforce, as part of a restructuring plan that would result in about $50 million/year in costs savings beginning in 2008.
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Full Text (417 words)
Copyright Chemical Week Associates Jan 7-Jan 14, 2008
[Headnote]
UNITED STATES/AMERICAS
Chemtura says its board has authorized management to "consider a wide range of strategic alternatives available to the company to enhance shareholder value." The company has formed a committee of independent directors to oversee the process and has retained Merrill Lynch to act as financial adviser.
"Strategic alternatives to be considered may include, among others, select business divestitures, value-creating acquisitions, changes to the company's capital structure, or a possible sale, merger, or other business combination involving the entire company," Chemtura says.
"We interpret the announcement as a signal that Chemtura's fundamentals, heavily dependent on housing and auto, have taken another step down after two years of unabated deterioration," says Edward Yang, analyst at CIBC World Markets (New York). "Three major restructurings in two years, an activist shareowner, and high management churn make a potential breakup likely."
Chemtura announced last April that it would eliminate about 620 jobs, or 10% of its global workforce, as part of a restructuring plan that would result in about $50 million/year in costs savings beginning in 2008 (CW, April 11/18,2007, p. 9). Under the plan, it discontinued antioxidant production at its Pedrengo and Ravenna, Italy facilities during third-quarter 2007 and sold its $20million/year organic peroxide business to Pergan (Bocholt, Germany) last June (CW, June 13, 2007, p. 39). Chemtura also sold its $35-million/year optical monomers business to Acomon (Zug, Switzerland) last October in order to "place greater focus on its core businesses."
Chemtura named Edward P. Garden, a principal and co-founder of hedge fund Trian Fund Management (New York), to its board last year after the fund acquired a nearly 5% stake in company. Trian says it "seeks to invest in undervalued and under-performing public companies, and prefers to work closely with the management of those companies to effect positive change through active, handson influence and involvement."
Industry sources say that Chemtura had received bids from possible buyers, including private equity firms, in early 2007, but that a deal was not completed.
Chemtura says it does not expect to disclose any further developments regarding its exploration of strategic alternatives unless and until the board completes the review.Chemtura's earnings improved in the most recent quarter for which it has reported. It posted third-quarter net income of $2 million (1 cts/share) including special items, compared to a $40-miIIion loss in the year-ago period. Sales rose 9%, to $950 million. Chemtura says it expects continued improvement in the fourth quarter, due in part to increased demand from the electronics industry
» Jump to indexing (document details)
Full Text (417 words)
Copyright Chemical Week Associates Jan 7-Jan 14, 2008
[Headnote]
UNITED STATES/AMERICAS
Chemtura says its board has authorized management to "consider a wide range of strategic alternatives available to the company to enhance shareholder value." The company has formed a committee of independent directors to oversee the process and has retained Merrill Lynch to act as financial adviser.
"Strategic alternatives to be considered may include, among others, select business divestitures, value-creating acquisitions, changes to the company's capital structure, or a possible sale, merger, or other business combination involving the entire company," Chemtura says.
"We interpret the announcement as a signal that Chemtura's fundamentals, heavily dependent on housing and auto, have taken another step down after two years of unabated deterioration," says Edward Yang, analyst at CIBC World Markets (New York). "Three major restructurings in two years, an activist shareowner, and high management churn make a potential breakup likely."
Chemtura announced last April that it would eliminate about 620 jobs, or 10% of its global workforce, as part of a restructuring plan that would result in about $50 million/year in costs savings beginning in 2008 (CW, April 11/18,2007, p. 9). Under the plan, it discontinued antioxidant production at its Pedrengo and Ravenna, Italy facilities during third-quarter 2007 and sold its $20million/year organic peroxide business to Pergan (Bocholt, Germany) last June (CW, June 13, 2007, p. 39). Chemtura also sold its $35-million/year optical monomers business to Acomon (Zug, Switzerland) last October in order to "place greater focus on its core businesses."
Chemtura named Edward P. Garden, a principal and co-founder of hedge fund Trian Fund Management (New York), to its board last year after the fund acquired a nearly 5% stake in company. Trian says it "seeks to invest in undervalued and under-performing public companies, and prefers to work closely with the management of those companies to effect positive change through active, handson influence and involvement."
Industry sources say that Chemtura had received bids from possible buyers, including private equity firms, in early 2007, but that a deal was not completed.
Chemtura says it does not expect to disclose any further developments regarding its exploration of strategic alternatives unless and until the board completes the review.Chemtura's earnings improved in the most recent quarter for which it has reported. It posted third-quarter net income of $2 million (1 cts/share) including special items, compared to a $40-miIIion loss in the year-ago period. Sales rose 9%, to $950 million. Chemtura says it expects continued improvement in the fourth quarter, due in part to increased demand from the electronics industry
Chemtura to Review Options, Including Possible Sale(job)
Chemtura to Review Options, Including Possible Sale
Chemtura says its board has authorized management to à "consider a wide range of strategic alternatives available to the company to enhance shareholder value”
"Strategic alternatives to be considered may include, among others, select business divestitures, value-creating acquisitions, changes to the company's capital structure, or a possible sale, merger, or other business combination involving the entire company,"
Restructuring plan (eliminate about 620 jobs, or 10% of its global workforce) à result about $50 million/year in costs savings
· "Seeks to invest in undervalued and under-performing public companies, and prefers to work closely with the management of those companies to effect positive change through active, hand son influence and involvement."
Chemtura says its board has authorized management to à "consider a wide range of strategic alternatives available to the company to enhance shareholder value”
"Strategic alternatives to be considered may include, among others, select business divestitures, value-creating acquisitions, changes to the company's capital structure, or a possible sale, merger, or other business combination involving the entire company,"
Restructuring plan (eliminate about 620 jobs, or 10% of its global workforce) à result about $50 million/year in costs savings
· "Seeks to invest in undervalued and under-performing public companies, and prefers to work closely with the management of those companies to effect positive change through active, hand son influence and involvement."
FREE CASH FLOW (FCF), ECONOMIC VALUE ADDED (EVA) AND NET PRESENT VALUE (NPV):
FREE CASH FLOW (FCF), ECONOMIC VALUE ADDED (EVA) AND NET PRESENT VALUE (NPV):
A Reconciliation of Variation of Discounted-Cash-Flow (Dcf) Valuation
INTRODUCTION:
“Discounted cash flow basically use for investment decision making and valuation is well entrenched in finance theory and practice”
Reconciliation:
FCF is more extensions of DCF concept to security valuation (techniques).
EVA is DCF concept to performance evaluating
NPV is a traditional application of DCF thinking (sometimes use for investment project selection)
1. CASH FLOW
“Basically is one of most important pieces of financial information, simply mean the differences between amount money that came and went out”
1. A. The cash budget identity
àComponent: operating revenues and cost, net security issuance, interest payment, dividend payment, taxes paid and net investment.
àPractice: investor need to bring the number into conformity with reality
Source = use
Rt + ∆CBt = Qt + Int++ Div t+ Taxes t + ∆l t + ∆WC t
1. B. Dividend
Dividend= (NPATt + depreciation) – total net investment + net debt issuance
1. C. Division of cash flow among investor
“Proponent of the FCFE method emphasize that free-cash-flow to equity is “….dividend that could be paid to shareholder”
--the difference between FCFE and dividend paid in given year may be characterized as investment in “excess marketable securities” and its omission from consideration is moot so long as such investment have zero NPV
Note: CFD = interest payment - net debt issuance
1. D. taxes
One of the components of cash flow to equity
Taxes: tax with no debt financing – interest-tax – shield benefit
Note: Adjustment is important!!!!!
E. Free cash flow to the firm
“ CFF is the sum of cash flow to equity (CFE) and cash flow to debt holders (CFD), reduced by the interest-tax-shield benefit from the cash flow to debt holder.
CFF = NOPAT1 + depreciation + total net investment
“CFF can be expressed as after tax operating profit from otherwise equivalent unlevered firm + dep – total net investment
2. VALUATION (basically to confirmed the conceptual equivalent of Various DCF procedures, given necessary information regarding cash flow)
“Three most basic business context in which issues arise are project valuation, security valuation, and firm valuation”
Purposeà to show conceptual consistency in valuation
2. A. equity by the dividend discount approach
2. B. Equity valuation by the free cash flow equity approach
Nb: for the A and B à same formula
2. C. debt valuation
2. D. total firm valuation
Similar with the CFF, but they are sigma before the formula
2. E. Project valuation
2. F. Economic profit (EP) and economic value added
“The concept of economic profit (EP) boil down to simple restatement of total firm valuation that “reallocates” investment expenditure from the period in which they are made to period over which their resulting benefit”
“the relocation assigns to each period an “EVAtm depreciation” component representing the “Usage” of portion of the cost of the firm assets plus “a capital charge” representing the opportunity cost of the remaining net investment in the firm.
3. MEASUREMENT ISSUE
Practice: the valuation task is carried out using information from a firm’s financial and tax accounting records.
Important use of valuation concepts requiring use of accounting information is determining of managerial compensation
3. A Derivation of operating cash flow from accounting profit
“As a result of application of the realization and matching principles and tax rules, accounting statement reporting of periodic revenues and cost may dedicative considerably from actual cash flow relating to the same revenues and cost item.
3. B. Derivation of economic profit from accounting profit
“as evidenced by the expression for economic profit, the economics profit approach discounted economics profit, rather than cash flow, and is therefore not only concerned with reconciliation of accounting profit and cash flow, but also focuses on issues defining the capital investment in the firm”
4.CONCLUSSION
Conceptually --- are equivalent
A Reconciliation of Variation of Discounted-Cash-Flow (Dcf) Valuation
INTRODUCTION:
“Discounted cash flow basically use for investment decision making and valuation is well entrenched in finance theory and practice”
Reconciliation:
FCF is more extensions of DCF concept to security valuation (techniques).
EVA is DCF concept to performance evaluating
NPV is a traditional application of DCF thinking (sometimes use for investment project selection)
1. CASH FLOW
“Basically is one of most important pieces of financial information, simply mean the differences between amount money that came and went out”
1. A. The cash budget identity
àComponent: operating revenues and cost, net security issuance, interest payment, dividend payment, taxes paid and net investment.
àPractice: investor need to bring the number into conformity with reality
Source = use
Rt + ∆CBt = Qt + Int++ Div t+ Taxes t + ∆l t + ∆WC t
1. B. Dividend
Dividend= (NPATt + depreciation) – total net investment + net debt issuance
1. C. Division of cash flow among investor
“Proponent of the FCFE method emphasize that free-cash-flow to equity is “….dividend that could be paid to shareholder”
--the difference between FCFE and dividend paid in given year may be characterized as investment in “excess marketable securities” and its omission from consideration is moot so long as such investment have zero NPV
Note: CFD = interest payment - net debt issuance
1. D. taxes
One of the components of cash flow to equity
Taxes: tax with no debt financing – interest-tax – shield benefit
Note: Adjustment is important!!!!!
E. Free cash flow to the firm
“ CFF is the sum of cash flow to equity (CFE) and cash flow to debt holders (CFD), reduced by the interest-tax-shield benefit from the cash flow to debt holder.
CFF = NOPAT1 + depreciation + total net investment
“CFF can be expressed as after tax operating profit from otherwise equivalent unlevered firm + dep – total net investment
2. VALUATION (basically to confirmed the conceptual equivalent of Various DCF procedures, given necessary information regarding cash flow)
“Three most basic business context in which issues arise are project valuation, security valuation, and firm valuation”
Purposeà to show conceptual consistency in valuation
2. A. equity by the dividend discount approach
2. B. Equity valuation by the free cash flow equity approach
Nb: for the A and B à same formula
2. C. debt valuation
2. D. total firm valuation
Similar with the CFF, but they are sigma before the formula
2. E. Project valuation
2. F. Economic profit (EP) and economic value added
“The concept of economic profit (EP) boil down to simple restatement of total firm valuation that “reallocates” investment expenditure from the period in which they are made to period over which their resulting benefit”
“the relocation assigns to each period an “EVAtm depreciation” component representing the “Usage” of portion of the cost of the firm assets plus “a capital charge” representing the opportunity cost of the remaining net investment in the firm.
3. MEASUREMENT ISSUE
Practice: the valuation task is carried out using information from a firm’s financial and tax accounting records.
Important use of valuation concepts requiring use of accounting information is determining of managerial compensation
3. A Derivation of operating cash flow from accounting profit
“As a result of application of the realization and matching principles and tax rules, accounting statement reporting of periodic revenues and cost may dedicative considerably from actual cash flow relating to the same revenues and cost item.
3. B. Derivation of economic profit from accounting profit
“as evidenced by the expression for economic profit, the economics profit approach discounted economics profit, rather than cash flow, and is therefore not only concerned with reconciliation of accounting profit and cash flow, but also focuses on issues defining the capital investment in the firm”
4.CONCLUSSION
Conceptually --- are equivalent
Trying Free Cash Flows to Market Valuations
Trying Free Cash Flows to Market Valuations
“In a companion piece to his article in the last issue*, Robert Howell turns his attention to the importance of free cash flow in determining valuations”
1. Introduction
Financial statement overhaul traditional format need major design à useful for meaningful financial analysis, decision-making, and value creation.
“Financial statement needs to put more emphasis on the free cash flow that a business generates”
2. Relating Free Cash Flows to Market Values
A firm’s market value reflects the collective judgment of the shareholder expectation in the future cash flow. If the expectation cash flow constantà Market value constant, is the expectation cash floe is betterà Market value should be raise, if the expectation cash flow is turn downà Market value is erode
“Management should regularly undertake those process to their own firm; Invertors should do the same to each infestation “
“ it is possible to directly relate a business’s free cash flow to its market value, financial statement should make this connection easy (today do not)
3. Managing for Free Cash Flows and Shareholder Value Creation
Management fundamental responsibleà increase shareholder valueà by increasing the NPV of the future system of cash flow.
There are there ways:
Increase cash earning by growing the business]
Reduce investment (managing working capital and fixed and other assets more tightly)
Financial management has two element
Managing the mix of capital to minimize the firm’s WACC
Using fee cash flow, or free cash flow after interest payment and debt service, to increase company future value.
“The ultimate financial management challenge is to use free cash flows to invest in new business opportunities that build shareholder value”
4. Xerox Corp. Profits vs. Cash Flows
This is example of how potentially misleading accounting profits can be…
Early 1999, stated that year 1998 is an excellent year à stock price climbing from $42 to $64
Throughout 1999, Xerox reported bad news “softness in its significant Brazilian market, a profit warning for the third quarter that stunned Wall Street, then another warning and large earning shortfall for the fourth quarter. à year end the stock price $20
May 2000 à the stock price fall to $5
“basically Xerox did was attribute more its leasing transaction to current (e.g., ’98 and ’99) revenues and profits than its should have” –because the added revenues booked only increased its receivable ad had no beneficial effect on cash flow --
5. Metrics to Monitor Free Cash Flows and Value Creation
Traditional financial statement analisis just focused on measures of “profitability” and “risk”.
Profitability fuccused à ROA and ROE
Risk measures à Liquidity and Solvency
“ROA often overstated, ROE also in most cases the resulting calculation is over stated”
ROA suffers for two account:
It fails to recognize the flow characteristics of working capital
Having fewer resources tied up in working capital is better in that it reduces the amount of cash required to support growth and improves ROIC
“Solvency measures are the times-interest earned ratio and various debt-to-capital ratios”
“if the company lax\ck adequate free cash flow to cover its debt service, it is insolvent, regardless of what ratios say”
6. Summary
Free cash flow has to be the focus of major financial statement overhaul and may be directly related to current market valuations to determine if the current free cash flows support current market values
“In a companion piece to his article in the last issue*, Robert Howell turns his attention to the importance of free cash flow in determining valuations”
1. Introduction
Financial statement overhaul traditional format need major design à useful for meaningful financial analysis, decision-making, and value creation.
“Financial statement needs to put more emphasis on the free cash flow that a business generates”
2. Relating Free Cash Flows to Market Values
A firm’s market value reflects the collective judgment of the shareholder expectation in the future cash flow. If the expectation cash flow constantà Market value constant, is the expectation cash floe is betterà Market value should be raise, if the expectation cash flow is turn downà Market value is erode
“Management should regularly undertake those process to their own firm; Invertors should do the same to each infestation “
“ it is possible to directly relate a business’s free cash flow to its market value, financial statement should make this connection easy (today do not)
3. Managing for Free Cash Flows and Shareholder Value Creation
Management fundamental responsibleà increase shareholder valueà by increasing the NPV of the future system of cash flow.
There are there ways:
Increase cash earning by growing the business]
Reduce investment (managing working capital and fixed and other assets more tightly)
Financial management has two element
Managing the mix of capital to minimize the firm’s WACC
Using fee cash flow, or free cash flow after interest payment and debt service, to increase company future value.
“The ultimate financial management challenge is to use free cash flows to invest in new business opportunities that build shareholder value”
4. Xerox Corp. Profits vs. Cash Flows
This is example of how potentially misleading accounting profits can be…
Early 1999, stated that year 1998 is an excellent year à stock price climbing from $42 to $64
Throughout 1999, Xerox reported bad news “softness in its significant Brazilian market, a profit warning for the third quarter that stunned Wall Street, then another warning and large earning shortfall for the fourth quarter. à year end the stock price $20
May 2000 à the stock price fall to $5
“basically Xerox did was attribute more its leasing transaction to current (e.g., ’98 and ’99) revenues and profits than its should have” –because the added revenues booked only increased its receivable ad had no beneficial effect on cash flow --
5. Metrics to Monitor Free Cash Flows and Value Creation
Traditional financial statement analisis just focused on measures of “profitability” and “risk”.
Profitability fuccused à ROA and ROE
Risk measures à Liquidity and Solvency
“ROA often overstated, ROE also in most cases the resulting calculation is over stated”
ROA suffers for two account:
It fails to recognize the flow characteristics of working capital
Having fewer resources tied up in working capital is better in that it reduces the amount of cash required to support growth and improves ROIC
“Solvency measures are the times-interest earned ratio and various debt-to-capital ratios”
“if the company lax\ck adequate free cash flow to cover its debt service, it is insolvent, regardless of what ratios say”
6. Summary
Free cash flow has to be the focus of major financial statement overhaul and may be directly related to current market valuations to determine if the current free cash flows support current market values
Rabu, 20 Februari 2008
Bonds: Risk, yield and spreads (article)
Bonds: Risk, yield and spreads
Patrick Bloomfield. Canadian Shareowner. Windsor: Mar/Apr 1999. Vol. 12, Iss. 4; pg. 56, 2 pgs
Abstract (Summary)
When buying bonds, look at market risk and credit risk. Market risk in the bond market is the fear that accelerating inflation, a credit crunch or central bank intervention will send interest rates higher and the prices of debt securities lower. Credit risk is the potential for the credit ratings of the company issuing the bond being reduced or eliminated, should the company's perceived ability to service its debt either diminish or disappear. To best fit the need to diversify a pure stock portfolio, the best quality of all are Government of Canada bonds.
» Jump to indexing (document details)
Full Text (1041 words)
Copyright Canadian Shareowner Magazine Inc. Mar/Apr 1999
STOCKS
Though you may not be consciously aware of it, when you study a stock using the Stock Selection Guide you are also assessing two kinds of risk - market risk and stockspecific risk.
You run your eye over the growth record of the company to evaluate the risk of that growth petering out. You also use the price/earnings and dividend yield evidence to assess the price you are being asked to pay, which is, in turn, a reflection of the degree of risk that investors as a whole are currently prepared to take by committing money to stocks.
BONDS
When you buy a bond, you go through much the same exercise. Only this time you are looking at market risk and "credit risk."
Market risk in the bond market is the fear that accelerating inflation, a credit crunch or central bank intervention will send interest rates higher and the prices of debt securities lower.
Credit risk is the potential for the credit ratings of the company issuing the bond you intend to buy being reduced or eliminated, should the company's perceived ability to service its debt either diminish or disappear.
The word "perceived" is italicized simply because a company or an individual's creditworthiness has to be a matter of judgment.
MEASURING CREDITWORTHINESS
There are many statistical measures of creditworthiness. In the case of corporations, the number of times that annual interest payments are covered by earnings before interest and taxes is an obvious and simple one, and one that readers in the securities business will have diligently slogged through as part of the Canadian Securities Course.
When it comes to governments, one is looking at a somewhat different set of measurements, including the strength or otherwise of the revenue base, the existing debt load, the state of the economy, and politicians' spending (or saving) intentions.
CREDIT RATING
In each case, the four rating agencies covering all or part of the Canadian debt markets - the Dominion Bond Rating Service (DBRS), the Canadian Bond Rating Service (CBRS), Standard & Poor's and Moody's - do a lot of very detailed investment math.
When it comes to corporate debt, they also take into account the outlook for the business sector in which a company operates, management strength, the impact of coming acquisitions, and profit potential (or lack thereof).
That is why a change in rating can have a pretty significant effect on the rate at which a country, province or corporation can raise money in the capital markets.
For corporations, a downward revision can have a particularly drastic effect, because it may well lower the rating to a point where the corporation's bonds are no longer either suitable or eligible for institutional investment.
The highest rating is pretty nearly always the debt of a central government.
In most countries outside Russia it is the central government that has the taxing power to raise taxes (and, hopefully, revenues) whenever there is any threat that interest payments will no longer be adequately covered.
BOND YIELDS
Thus Ottawa's domestic debt gets the highest rating from Standard & Poor's (triple A), DBRS (triple A) and CBRS (AA+). Even here, however, opinions differ. Moody's rates our federal government's domestic debt at its second highest notch (Double A1).
In turn, Government of Canada bond yields (4.90% for five-year maturities, 5.01% for 10-year and 5.32% for 30 year at the time of writing) are the yields against which the rest of the market is priced.
For instance, the Ontario government's ratings (double A from CBRS and single A, high, from DBRS) are a notch or more lower than Ottawa's - and an Ontario bond with 30 years to run was priced the same day at a yield of 5.76%.
Progressing further down the ratings scale, and further up the yield pattern, corporate bonds generally have lower ratings and higher yields.
YIELDS SPREADS
Loblaw Companies Ltd. has a low A+ from CBRS (indicating pretty good quality) and a high A from DBRS (indicating satisfactory quality). Its bond with a shade less than 10 years to go was priced the same day at 6.51%, something more than a percentage point higher than the Government of Canada 10year level.
These, however, can never be absolute comparisons. In practice, there are other significant differences between the federal, provincial, municipal and corporate bond markets.
The Government of Canada market is the largest and most liquid of the four.
One portfolio manager responsible for the bond holdings of a bunch of sizeable private clients argues that there is often little reward in seeking a modestly higher yield for the additional risk of venturing outside Government of Canada's.
Like others of the same view, he might include provincial bondholdings - if he were satisfied that his clients were being correspondingly rewarded. John Grundy, a seasoned bond hand well known to the Toronto community and now living in Regina, argues in his set of web pages that the time to buy corporate bonds is when there is an international flap on and investors are stampeding for the best investment quality they can find.
He cites the flight to quality last fall as a great example. Yield spreads, which had been unusually narrow, widened to the point where there was an unusually high reward for doing the opposite to the crowd and buying good-quality corporates.
Since then, the yield spread has narrowed, but by no means universally, suggesting there are still opportunities out there.
DIVERSIFICATION
Whether they are ideal opportunities for readers of this publication is another matter. In most instances, the need will be to achieve some diversification of the risk of a pure stock portfolio. In that instance, the best quality of all, Government of Canada bonds, would seem to fit the bill better than most.
A complaint I have also heard is that it is a tough task finding the necessary diversification for the relatively modest proportion of a private investor's portfolio that would typically be allocated to the corporate bond market.
That is likely to change as governments pay down their debts and corporate borrowers increase their share of the market.
On the other hand, that same process will likely put a greater premium on a reduced supply of Government of Canada and provincial issues.
Patrick Bloomfield. Canadian Shareowner. Windsor: Mar/Apr 1999. Vol. 12, Iss. 4; pg. 56, 2 pgs
Abstract (Summary)
When buying bonds, look at market risk and credit risk. Market risk in the bond market is the fear that accelerating inflation, a credit crunch or central bank intervention will send interest rates higher and the prices of debt securities lower. Credit risk is the potential for the credit ratings of the company issuing the bond being reduced or eliminated, should the company's perceived ability to service its debt either diminish or disappear. To best fit the need to diversify a pure stock portfolio, the best quality of all are Government of Canada bonds.
» Jump to indexing (document details)
Full Text (1041 words)
Copyright Canadian Shareowner Magazine Inc. Mar/Apr 1999
STOCKS
Though you may not be consciously aware of it, when you study a stock using the Stock Selection Guide you are also assessing two kinds of risk - market risk and stockspecific risk.
You run your eye over the growth record of the company to evaluate the risk of that growth petering out. You also use the price/earnings and dividend yield evidence to assess the price you are being asked to pay, which is, in turn, a reflection of the degree of risk that investors as a whole are currently prepared to take by committing money to stocks.
BONDS
When you buy a bond, you go through much the same exercise. Only this time you are looking at market risk and "credit risk."
Market risk in the bond market is the fear that accelerating inflation, a credit crunch or central bank intervention will send interest rates higher and the prices of debt securities lower.
Credit risk is the potential for the credit ratings of the company issuing the bond you intend to buy being reduced or eliminated, should the company's perceived ability to service its debt either diminish or disappear.
The word "perceived" is italicized simply because a company or an individual's creditworthiness has to be a matter of judgment.
MEASURING CREDITWORTHINESS
There are many statistical measures of creditworthiness. In the case of corporations, the number of times that annual interest payments are covered by earnings before interest and taxes is an obvious and simple one, and one that readers in the securities business will have diligently slogged through as part of the Canadian Securities Course.
When it comes to governments, one is looking at a somewhat different set of measurements, including the strength or otherwise of the revenue base, the existing debt load, the state of the economy, and politicians' spending (or saving) intentions.
CREDIT RATING
In each case, the four rating agencies covering all or part of the Canadian debt markets - the Dominion Bond Rating Service (DBRS), the Canadian Bond Rating Service (CBRS), Standard & Poor's and Moody's - do a lot of very detailed investment math.
When it comes to corporate debt, they also take into account the outlook for the business sector in which a company operates, management strength, the impact of coming acquisitions, and profit potential (or lack thereof).
That is why a change in rating can have a pretty significant effect on the rate at which a country, province or corporation can raise money in the capital markets.
For corporations, a downward revision can have a particularly drastic effect, because it may well lower the rating to a point where the corporation's bonds are no longer either suitable or eligible for institutional investment.
The highest rating is pretty nearly always the debt of a central government.
In most countries outside Russia it is the central government that has the taxing power to raise taxes (and, hopefully, revenues) whenever there is any threat that interest payments will no longer be adequately covered.
BOND YIELDS
Thus Ottawa's domestic debt gets the highest rating from Standard & Poor's (triple A), DBRS (triple A) and CBRS (AA+). Even here, however, opinions differ. Moody's rates our federal government's domestic debt at its second highest notch (Double A1).
In turn, Government of Canada bond yields (4.90% for five-year maturities, 5.01% for 10-year and 5.32% for 30 year at the time of writing) are the yields against which the rest of the market is priced.
For instance, the Ontario government's ratings (double A from CBRS and single A, high, from DBRS) are a notch or more lower than Ottawa's - and an Ontario bond with 30 years to run was priced the same day at a yield of 5.76%.
Progressing further down the ratings scale, and further up the yield pattern, corporate bonds generally have lower ratings and higher yields.
YIELDS SPREADS
Loblaw Companies Ltd. has a low A+ from CBRS (indicating pretty good quality) and a high A from DBRS (indicating satisfactory quality). Its bond with a shade less than 10 years to go was priced the same day at 6.51%, something more than a percentage point higher than the Government of Canada 10year level.
These, however, can never be absolute comparisons. In practice, there are other significant differences between the federal, provincial, municipal and corporate bond markets.
The Government of Canada market is the largest and most liquid of the four.
One portfolio manager responsible for the bond holdings of a bunch of sizeable private clients argues that there is often little reward in seeking a modestly higher yield for the additional risk of venturing outside Government of Canada's.
Like others of the same view, he might include provincial bondholdings - if he were satisfied that his clients were being correspondingly rewarded. John Grundy, a seasoned bond hand well known to the Toronto community and now living in Regina, argues in his set of web pages that the time to buy corporate bonds is when there is an international flap on and investors are stampeding for the best investment quality they can find.
He cites the flight to quality last fall as a great example. Yield spreads, which had been unusually narrow, widened to the point where there was an unusually high reward for doing the opposite to the crowd and buying good-quality corporates.
Since then, the yield spread has narrowed, but by no means universally, suggesting there are still opportunities out there.
DIVERSIFICATION
Whether they are ideal opportunities for readers of this publication is another matter. In most instances, the need will be to achieve some diversification of the risk of a pure stock portfolio. In that instance, the best quality of all, Government of Canada bonds, would seem to fit the bill better than most.
A complaint I have also heard is that it is a tough task finding the necessary diversification for the relatively modest proportion of a private investor's portfolio that would typically be allocated to the corporate bond market.
That is likely to change as governments pay down their debts and corporate borrowers increase their share of the market.
On the other hand, that same process will likely put a greater premium on a reduced supply of Government of Canada and provincial issues.
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