Empirical capital structure: A review, Foundations and Trends in Finance Flashcards Preview

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Flashcards in Empirical capital structure: A review, Foundations and Trends in Finance Deck (21)
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1

Lifecycle theory

During the rapid growth stage there are many positive NPV projects, investment banks charges for IPOs, so it is more beneficial to sit on cash to finance all those attractive investment projects -> a few dividends pay out (all money reinvested)

During the maturity period there are a few positive NPV projects -> pay out dividends rather than burn cash in NPV < 0 projects. Likely Agency costs -> impose high dividends payouts as a disciplinary measure

2

De Angelo’s proposition

Payout policy is a trade-off between agency costs and capital raising costs

3

Reasons to pay high dividends

Clientele effect
Low growth companies
Agency costs
Signaling theory
Bird in hand theory

4

Reasons to pay low dividends

High issue costs
Tax effect
Clientele effect
Costs of financial distress
Good growth prospect

5

Advantages of repurchase

Preserving financial flexibility
Correct stock valuation
Remove low valuation stockholders
Allocation of voting rights
Increase reported EPS
Transaction costs saving

6

Why Preserving financial flexibility is a reason of repurchase

- No need for future payments

7

Why Correct stock valuation is a reason of repurchase

- Buy when undervalued
- Exploit shareholders (arguable)

8

Why Remove low valuation stockholders is a reason of repurchase

- Increase the value
- Avoid takeovers

9

Why Allocation of voting rights is a reason of repurchase

- Remove threatening block holders
- Increase management ownership

10

Why Increase reported EPS is a reason of repurchase

- Simply due to fewer shares
- Productivity growth

11

Why Transaction costs saving is a reason of repurchase

Less shareholders => less “paper work”
- Small firms

12

“residual” theory

pays cash when has it left

13

Factors that influence payout

o Signaling and information distribution
o Investor’s mental accounting and behavioural biases
o Managerial over-confidence and biases
o Taxes
o Consumption demand
o Clientele

14

Signaling and information distribution

 Challenge to M&M irrelevance theorem (Stock prices react to div. announcements)
 Earnings vs payouts (price changes reflect changes in expected level of riskiness of payouts but not always expected earnings)
 Hard to choose how to signal
 Wrong firms pay dividends (should – young, small, do – old, large)
 Mgrs. careful about dividends (reluctant to cut, so often don’t raise) – dividends only a complimentary tool for communication
 Stakeholder relations supported (labour unions)

15

Investor’s mental accounting and behavioural biases

 Demand biases (consume only from dividends)
 Trends/fashion
 Catering theory, but “homemade dividends”

16

Homemade dividends

Homemade dividends is a concept that in liquid markets an investor can alter a company's dividend policy to match his own cash flow objectives. ... It suggests that investors are indifferent between dividends and capital gains because total return on a stock is made up of both dividends and capital gain.

17

Managerial over-confidence and biases

 Convince investors that no agency costs exist
 Overconfident CFOs – lower return projects, pay divs less often, repurchase stock more frequently

18

Clientele

stockholders differ in their desires in divs vs capital gains
 Taxes
 Government regulation
 Transaction costs
 Not realistic – wouldn’t be able to diversify, as pay/don’t pay div. firms similar

19

What about is article

Authors would like to argue in this paper that adding a friction to the Fisherian Model, particularly asymmetric information, yields an FCF-centric theory that explains the timing and the magnitude of payouts over the lifecycle of a corporation.

20

3 Reasons why investors are willing to consume from dividends:

(i) they are unwilling to sell too many stocks now,
(ii) they feel that they might regret in case that share price increases,
(iii) marginal utility from one dollar of dividends exceeds the marginal utility of the tenth dollar of capital gains.

21

Conclusion of the article

Authors conclude that the massive dividends consistently distributed over many decades primarily reflects the corresponding large earnings that dividend payers have generated over the years, and they are not influenced so much by the investor sentiment on firm’s dividend decisions.