Dividend Policy

This week is about dividend policy. Dividend policy is decision of the proportion of profit share to shareholders-generally periodically. There are some theories analyzing dividend policy. One of them is Miller and Modigliani’s dividend irrelevancy proposition. It claims that dividend policy is not relevant to shareholder wealth, basing on rigid assumptions such as no taxes, no transaction costs, all investors knowing all relevant information, all investors can borrow and lend at the same interest rate etc. Another is dividends as a residual. It assumes that it is so expensive to raise external finance. Earnings are the sole source to invest. Basing on this, dividend policy can influence on shareholder wealth deeply. However, in the real world, it is not simple as the two theories. In the real world, dividend policy is influenced by many factors and designing dividend policy is complicated. There are some elements which influence on the dividend policy, such as clientele effects, taxation, dividend as conveyors of information, agency theory, uncertainty, potential of firm etc.

Royal Dutch Shell plc, generally called as Shell, is an Anglo-Dutch multinational oil and gas company and is one of the six oil and gas companies. According to Yahoo Finance (2013), since 2011, the board of Royal Dutch Shell plc decided increased their dividend slightly. From 2011 to 2012, interim dividend increased to $ 0.43 per ordinary share and it increased by about 2.3% than the previous year. In 2013 the board expects that the first quarter interim dividend will be improved to $ 0.45 per ordinary share and it improves by over 4.7% than the same quarter in the previous year. In addition, Royal Dutch Shell plc offers dividends in cash and scrip dividends for shareholders. (Source from Yahoo Finance)

In the case, in my opinion, there are some reasons why the manager decided a slightly and stable increase of dividend policy. First of all, the company creates a large number of free cash flow. According to CEO of the company, Peter Voser, from 2009 to 2012, he said that their company achieved the aim which increased by 80% of cash flow. (Yahoo Finance, 2013) this makes more capability to return for shareholders. In addition, According to dividends as conveyors of information, dividends appear to act as a significant conveyor of information about companies. Shell plc utilizes the stable and slightly increase dividend policy to express that directors view the earning of company and the future of the company with optimistic. I think it is benefit to attractive for shareholders’ investment. And during the good earnings of Shell time, the company avoids paying high return for shareholders. This can avoid losing effects of predictability and stability cherished by shareholders when the company falls into bad earnings time. Meanwhile, according to clientele effects, different shareholders prefer different a dividend pattern. Basing on Arnold (2005), pension funds, trust funds and insurance companies prefer to invest the company which has a stable dividend policy. Thus Shell’s dividend policy will attract to institutional investor. On the other hand, Shell adopts dividend in cash and scrip dividend. This can decrease the number of cash leaving company and make the company keep more cash flow. Thus Shell chooses this dividend policy.

Capital Structure

Capital Structure

This blog will introduce capital structure of companies. The company pursue maximizing shareholder’s’ wealth and company value. By decreasing the weighted average cost of capital (WACC), companies can improve shareholder’s wealth and company value. Debt is a lower cost than equity. Meanwhile, debt can reduce taxable profit. Thus by increasing proportion of debt in the whole capital, WACC will decrease. In other words, improving gearing ratio will create more company value. However, with increase of gearing ratio, the company will have high risk of financial distress. Meanwhile shareholder will require high return. In addition, the company also face business risk. Hence, managers should choose a suitable proportion of equity and debt, in order to build optimal capital. On the other hand, according the theory of Modigliani and Millar, it claims the total value of any company is independent of its capital structure. Thus there is no optimal structure. However, this theory is established under many assumptions such as there is no taxation, there are no costs of financial distress and liquidation, individuals can borrow as cheaply as corporations. Because the assumptions are rigid, I think it is difficult to implement.

Li Ning is a famous company in China which run sport clothes. Its CEO, Li Ning was an outstanding gymnast. On January 2013, this company issue 241 million dollars of bond. The company increase its gearing ratio again. Last year, it has raised 120 million dollars by bond. In fact, since 2008 the company has adjusted its capital structure in order to occupy market share. In 2008, china holds Olympic Games. Li Ning represents Chinese people lighted final Olympic flame. Li Ning catches this marketing opportunity and expands a number of its shops in China. To achieve this, in 2008 the company’s gearing ratio increased to 52%. (Li Ning Annual Report, 2009) Compared its competitor, Anta’s gearing is 10% in 2008. (Anta Annual Report, 2009)Within five years, Li Ning company has been utilizing this capital structure which is high gearing. However, these years the economic is slump and purchasing power keep low. Thus Li Ning makes a large number of inventory with its sharp expand. This leads its cash flow became intense. To remit this, Li Ning has to issue bonds again in 2013. (Financial Times, 2013)

In this case, in order to extend sharply, manager adopts capital structure with high gearing. This capital structure is low raising cost and reduces taxable profit. And it is effective to expand. Li Ning’ shops have exceeded Adidas in China. However, the manager may pay less to its shortcomings or the manager may prefer to high risk, and this leads to the company value decrease. Because economic slumps and expand is sharp, there are large stores and intensive cash flow. These make business risk and financial risk. Meanwhile, clothes retailer is sensitive for general level of economic activities. Thus the capital structure increases risk of financial distress. Furthermore, such high risk makes shareholders require high return, but it cannot be satisfied. As a result, from 2011 to 2013, its share price decreases from about 17 HK Dollar to almost 4.8 HK dollar. (Business Week, 2013) this decreases company value.

Therefore managers should balance proportion of equity and debts in capital structure, according to their industries and aims. Also how to find the good point which balances risk, develop and cost is a challenge for managers. 

Family Business

Family business is significant. In respect of family business in the ME, in 2002, 80% corporations are controlled by one family. Meanwhile, In 2008 family business contribute wealth takes account 31% among GDP in the UK and It offers 9.5 million jobs for people. In addition, in the top 500 firms, family business takes account for 35% and provides 50% jobs. Thus family business influences our society deeply, and we should pay more attention to family business. According to Reginald (1995), the manager who is a member of family will pay more attention to their company than professional managers and they focus on long-term development of company. However, family business faces many problems. One of major problems is how to financing about family business. In unlisted family business, they are closed external environments and keep mystical. Thus it leads that investors cannot get information and do not invest them. Therefore family business often obtains money from relatives and bank. it leads that family business cannot obtain a large number of money to expanse business. In listed family business, the managers who are the member of family pay more attention to their own needs rather than investors. This leads to investors not trusting the family business with their wealth. Thus family firms grow slowly.

Another major problem of family business is inheritance. When the person who create firm become old, which one will inherit the firm? He has more than one child. He chooses the inheritors depending on age? Intelligence? In addition, he may choose one to inherit and manage the firm, but his other children may not obey and fight with their brother or sister. It is a disaster for a firm. However in the real world it often appears. For example, in Samsung Group, the chairman is Lee Kun-hee who is the youngest one among his brothers and sisters. In 2012 he is charged by his brothers and sisters. They assert that Lee Kun-hee hides their father’s wealth and required Lee Kun-hee return the wealth. Finally Lee Kun-hee obtains successful for the charge and keeps his position in Samsung Group. However, this news will influence Samsung Group negatively. Lee Kun-hee had to pay more attention to charge. It leads that he cannot devote himself to manage group. This leads other shareholders’ wealth is damaged. In addition, It is harmful for the group’s image. 

Credit Crunch

Credit Crunch is defined as a serious shortage of money. it shows that lending institution credit money to high risk people and institutions, and at that time real estate market is slump and the price start to decrease. In 2008 credit crunch started French bank Paribas. Then it liked domino effect. Credit crunch spread to the whole world. In US, the biggest companies called Freddie and Fannie Mac were takeover by US government. In addition, Lehman Brothers and Morgan Stanley also faced risk of bankrupt. In European so many countries’ bank suffered same situations.Meanwhile, the companies are difficult to finance and survive in this situation.

The Fed pumped money into the US economy and slashed its main interest rate which the Federal Funds rate decrease from 3.5% in August 2001 to a mere 1% by mid-2003. The Fed held this rate too low for too long. The Credit Crunch was exploded under this policy. The US sub-Prime mortgage market is one of the reason causing Credit Crunch. In US many America consumers having lower salary have to sold their owning property. This was because the banks were lending at a cheap rate. And this led people were willing to accept mortgage. With the increase of leading amount, the banks make the debt turn into the form of a CDO (Collateralised Debt Obligation). This led this situation-if the morgages were pooled together, this was a risky investment; however, if the morgages was the repayment pooled together, this was less risky. These behaviours attract to investors to invest this market.

However, when people could not pay their mortgage, the problems increased. Other banks/lenders did not cooperate with them since they can nor sure if they re-mixed again because of lack of transparency of the market. This made a lowest levels of interbank lending.

Mergers & Acquisitions

Merger means the combining of two business entities under common ownership. And most commentators use merger and acquisition and takeover interchangeable. According to economic or strategic definitions of mergers, it can be divided into three categories: horizontal, vertical and conglomerate. Merger motives include synergy, bargain buying, managerial motives and third party motives.

HONG KONG, Feb 5, SABMiller, which is the world’s second–biggest brewer, purchase Kingway Brewery assets for 5.38 billion yuan. SABMiller will control seven breweries of Kingway with this acquisition. Four are in Guangdong province which is one of fast growing and most affluent regions in China. The other breweries are in Sichuan, Shanxi and Tianjin. Kingway said in 2012 it decided to dell brewing operations since its profit was being hit by competition and rising costs. In 2012, Beijing Yanjing which is the fourth-largest domestic brewer in China want to acquired Kingway, however, in final round of bidding, it failed. In 2013, J.P Morgan acted as financial adviser to SABMiller. As a result of this deal, Kingway share price in HONGKONG stock market increased almost 20% (Hongkong stock market, 2013), meanwhile, SABMiller shares grew up 0.9 %. (These source from Yahoo Finance, 2013)

In the case, I think it is a suitable time for SABMiller to acquire Kingway by a lower price. According to statement above, Kingway faces a decrease of profit and in the first acquisition with Beijing Yanjing, it failed. These negatively influenced the price of acquisition of Kingway. In the respect of result, the target company, Kingway, shares increase 20%. The bidder, SABMiller, shares increased 0.6%. In the long term, personally I am optimistic for the horizontal M&A. Kingway is the most popular brand in Guangdong province and Sichuan, Shanxi and Tianjin. SABMiller also controls CR Snow which owns best sales of beer in China. Thus larger size between Kingway and SABMiller will create economic of scale in term of research and development, as well as purchasing. Meanwhile ‘the acquisition of Kingway asset gives us greater access to high growth and attractive regional markets in China, thereby enhancing CR Snow’s competitive position.’ SAB Asia Pacific managing director Ari Mervis Said. It increases SAB market share and competition in developing Chinese beer industry. In addition, Kingway can learn high level of management skills and marketing skills from multinational company, SAB. In this way it can increase its competition. Furthermore, SAB have experience about acquisition with Chinese company. It will decrease risk of conflict of culture and it is benefit for integration. These factors above will create strong synergy effect.

Foreign Direct Investment

This week’s content is about foreign direct investment. foreign direct investment is the purchase of physical assets or a significant amount of the ownership (stock) of a company in another country to gain a measure of management control. It includes greenfield investment and international Merger and Acquired Activity. FDI can bring a lot of benefit for host country which includes obtaining overseas resources, drive economic growth, increase local capital markets. However, it also has some costs such as environmental damage, human rights implication. There are some reasons to explain why transnational enterprises such as transportation costs, impediments to exporting.

According to Financial Times (2013), in 2012 FDI in china decrease and it is the sharp decrease after European debt crisis. On one hand, it is influenced by European debt crisis. On other hand, it is because Chinese labour cost keeps increasing during these years. In some province the labour cost increases by 40% each year. Meanwhile because of one-child policy, a number of labour costs will reach peak in 2-3 years. Furthermore, India, Vietnam and Brazil become popular in FDI.

In the news, obviously, multinational companies choose china because Chinese had low labour cost in past years. Meanwhile, I think multinational firms also choose china as host countries because Chinese market is large. According to Financial times (2012), Chinese is second largest economic entity in the world. It means Chinese itself has large demand for products. Thus multinational firms invest directly in china can decrease their transportation cost and seize this market. Thus these are why Chinese can attract to FDI in past years although it became decrease in 2012.

According to the news, India, Vietnam and Brazil become popular for multinational firms to invest. Obviously, it is because these countries have low labour cost. However, these countries’ infrastructure is backward. Thus these will increase the firm’ cost. In addition, in Vietnam the policy of the country is freer than China. The labour in the country may strike to require increasing their salary. (Financial Times, 2012) Therefore multinational firms have to face these problems.

In respect of host country, obviously, FDI made a large contribution for Chinese economic development. FDI brought the skills for manufacturer, capital, management skills and employment effect to china. These drive to Chinese economic development. However, FDI also brought negative influence on China such as environmental problems and human rights. One of famous news is Apple manufacturer in China. It damages the human right on Chinese labour and also blame Apple’s reputation in the world.

Tax Management and Exchange-rate Risk

Tax plays an important role in corporate management. Tax can influence on strategic planning, cash flow and investment. Tax is treated as cost. In order to maximize shareholder’s wealth, companies try to avoid or decrease tax burden. Meanwhile, by reduction of tax, company can obtain low cost and design a competitive price to obtain competitive advantage. To achieve this objective, multinational enterprises which have capability and expertise can utilize subsidiaries or joint ventures to re-structure, transactions, or transfer pricing.

The multinationals, Starbucks, Google and Amazon were explored by newspaper. Especially Starbucks’ profit in UK creates 3.1billion pounds in past three years. But it just contributes 8.6million taxes. People in UK are angry about Starbucks and appeal to resist Starbucks. They think Starbuck escape the responsibility for society. In order to deal with resist, Starbucks makes a commitment which it will pay 20 million pounds of incomes taxes, and this money has exceeded the legal payable taxes. Google and Amazon have same situation with Starbucks. They are all legal. Google takes advantage of its subsidiaries which locate in Ireland to obtain a low tax rate. Amazon utilizes its subsidiaries which located in tax haven Luxembourg. (BBC, 2013)

In these cases, personally, in order to obtain high profit and competitive advantage, companies are motived to avoid taxes by legal means. However, while financial managers catch low payment tax, the reputation is damaged. As Starbucks, people began to resist it. The company is regarded as irresponsibility for society. Meanwhile it is not an ethical behavior. In order to repair reputation, company has to pay more money. Thus tax is a complex problem. Companies should make a balance between their benefit and society responsibility.

Nowadays, more and more multinational companies appear. Within international trade, they face exchange-rate risk. There are three type risk which is transaction risk, translation risk and economic risk. Transaction risk is associated with imports or exports. The firm may have a commitment in a foreign currency and will have a variable value because of exchange-rate movements. Translation risk arises because financial data denominated in one currency are then expressed in terms of another currency. Income, expenses, assets and liabilities which is overseas have to be re-expressed in terms of home currency. In respect of economic risk, a firm’s economic value may decrease as a result of forex movements causing a loss in competitive strength. In order to decrease risk, companies can utilize hedge such as Netting, Matching, Futures Hedge, currency option hedge.

Recently, Japanese government reduce JPY Exchange Rate. JPY Exchange Rate has reduced 10% since on January 2013. (Financial Times, 2013) This measurements support increase of company competitive such as Toyota and Panasonic. This leads Japanese products have lower price than other countries. However, the price of import energy source will increase sharply. These companies who need to import source will increase their cost. If these companies does not use hedge, because of increase of exchange rate, they may suffer large loss.