Dividend or Capital Gain?

An optimal capital structure investigation has delivered an understanding towards how different companies balance their debt and equity. Now, as I want to discuss the dividend and capital gain that are much more into the weighing of equity; forget about debt.

 

This topic finally elaborated the real distribution of shareholder wealth maximisation which indeed the core of the entire module, the value generation. Many issues were communicated as the approaches to obtain the SWM- for example from M&A, risk managements and multinational tax; therefore I think actual systems that will shape those attempts should be explored as well.

There are two classifications for shareholders to acquire wealth from the company, which are through dividend and capital gain, or in the perspective from the company itself, this is how they focus on producing the money for their shareholders. A divided can be known as the payment given to the investors based on the company’s earnings that they decided not to keep, usually developed business more take advantages from this system. Capital gain in addition is a gain by which the company increased the performance and thus can give shareholders or investors gain above the level of money that they are invested in. In fact, researches showed that growing firms will tend to utilize it. From these illustrations, which one do you prefer when you became an investor in one company then?

Some, without a doubt may prefer to have capital gain compared to the dividend. I consider that this is specifically for ‘small and short term investors’ who see elements such as EPS when doing the investment. Let’s take a look at company like Research in Motion (RIM) that I showed in this following graph.

 

Share prices were likely to fluctuate yet increase if seen here, thus I can further say that it will give access to the investors to buy or buy back and sell it when appropriate time comes. Moreover EPS increases as the share price rise; immediate action and earning will be obtained by them accordingly. If for instance they buy on April 22, 2013 with price $13.99 and sell it tomorrow with each share $14.33, some increases in wealth have been achieved by the simplest way. That is why that type of investor will choose to have capital gain rather than dividend because without getting involved in the company and take consequence of long term uncertainty, they could earn some money. However they sometimes lean to huge loss when the share price plummeted.

On the contrary, increasing in share price does not reflect a higher dividend payout, however the argument says that ‘big shareholders’ who generally take part in the course of business prefer the dividend because even though level of future uncertainty is high, capital gain has even higher insecurity due to the ‘loss’ mentioned previously. At least, investment worth 0, rather than huge negative value comes out. 

In my opinion, however, as a company they should focus on different angles to let gratification are received by both types of shareholders, not only capital gain and but also the dividend payment, as there is such theory which explained that if the company does not pay dividend, investors will change over and it leads to the decreasing in share price. Financial managers should also have the ability to control every decision in the company by enhanced strategies so that they can invest in the right company, yet still able to finance and give high payment to the shareholders. What I mean here is that they need strategy to provide decent amount of dividend at first, but still do the investments opportunity that have +NPV that will cover all the costs of capital, and pay it to the shareholders higher when the cash derived. While waiting for it, they have to make assurance that performance goes well, so that share price may grow and the ‘big shareholders’ can provide theirselves with extra dividend by buying-selling-buying back some of the shares that they have.

Hence almost certainly they can provide high divided as well as capital gain like these below firms in the future and shareholders can feel worthwhile waiting for the company to become their loyalties.

Optimal Capital Structure

Debt and equity are considered to be an optimal capital structure. Its definition is commonly the techniques that firms should effectively utilize the available sources of finance to inject their capital to operate their business. There is a relation between this concept with the shareholders’ return after all; and thus one of could be considered and chosen as ‘more optimum’ as it will lower the overall cost of capital. In other words, we should have best capital structure by having right amount of equity and debt to cover the return required by the company.

As you can notice in my 3^rd blog, I had indicated that debt will be a much cheaper cost of finance that company could use rather than capital, which can make them happily reduce barrier to find a very high rate of return investments. But still, considering the risk of debt experienced by many businesses, including the one that had happened to Beazer Homes USA, Inc., is really necessary. 

The main issue today is that can you as a financial manager employ through your capital structure, on which way you weighted your cost of capital and which that will increase the project performance spread the capital by the and increase shareholder value. How can we alter our way to make the optimal capital structure in consequence?

In particular certain companies will have its own best fits because of the type of business that they are doing, but almost certainly more leverage can meant for more return. If looking at Sainsbury Plc., their strategy until recent time is by using the debt. The proofs are that the growth number of debt is higher in comparison to its equity according to its 11.89% rise in long term borrowings, while there is only 3.78% in its RE and reserves by the end of 2012. It is then the lower issue, transaction and monitoring and Sainsbury can use the tax advantages from it also, yet they should be able to control the cost financial distress risk which at this point cost of capital is started to increase again.

Additionally, Sainsbury need to be careful because shareholder value can be cut afterwards if the ‘down’ moment came, high debt will lead the company decide not to pay dividend to their shareholders and so on. The management of Sainsbury should take further concern that debt may also increase the WACC in terms of shareholder return as they need to be compensated. Undoubtedly, Sainsbury in this case could add only up to a certain point by assessing a traditional theory.

Were the Real Financial Regulators Actually Existed?

In the world of finance, there are thousands of systems created to keep financial institution in a sustainable position and it make an extremely complex to handle. That is why regulator employed in it, basically to block the governance problems which I had explained in the last blog post. According to Suarez&Weisbrod (1996), regulators are the one; either nongovernment or government body that provide and give clarifications on the banking’s working procedures for everyone’s confidence

At this time, the more solemn debate among quite a lot of parties is occurred because they wondered whether the regulators are there in between financial institutions to regulate them. The most powerful background was the challenge of banking and global financial crisis back to several years ago when the corporate governance was not clearly constructed- giving worst impact to the world economy.

Until these days, I can see that demanding problem regarding to this has not been successfully resolved. Do you consider that this down to the regulators’ work absence or actually there are some others that could make it? It is seen from George Soros analysis that regards to the European banking system. (Worstall, 2012) He sees that regulators were not doing as it is supposed to be because it was such a really odd approach when they created capital weights on sovereign debts. This was from the regulators’ permission from banking industries to take much hold on government bonds and left Germany struggled with its operation at the end, while others like could just easily enjoy the cheap credit offered.

As commercial banks have successfully made a use of those weaker bonds that would increase additional benefits, I consider that this could bring bad impact to the banks itself and in turn to a competition that digressed since this occasion gives emphasis that the credit wouldn’t be that worth enough to be given to the other countries. This accordingly countered to one of Minsky’s (2003) explanations which covered that ‘debt burden and falling appetite put upward pressure on interest rates’ as the fact low credit interest rate were given.

Today, comparable stories also occurred. Not capital weights’ problem but another time, Heritage Bank of Florida finally failed in the market on November 2^nd last year because of the customers’ late payment of debt (asset troubled ratio), in addition to Frontier Bank’s fraud (the fraud from bank explained in my previous writing - BCG) which due to its employee’s scam.

Though different cases are happened, it actually figured out my thought to answer the primary question of ‘Were the real financial regulators actually existed?’ Based on this case I realized that therefore regulators are definitely existed to regulate; not their fault, however they had performed inadequacy of exertion though this can be said that it all about the irresponsibility and mismanagement from the banks itself.

At this point, I see justification from the regulation and penalty settings developed by the regulators, for instance Frontier’s Senior Executive who correspondingly been arrested for doing such immoral action that disadvantaged many parties. But then through anything, besides risk management made by the bank, regulators should anticipate and control what the banks are actually doing which is the only factor to blame. In fact banks indeed rewarding the risk taking, yet regulators must control their risk taking.

The Appraisal of Corporate Governance Significance in Banking Sector

Year 2006-2007 were a prosper moment for banking industry. Employees, Employers, shareholders; all levels of managements were benefited from this. Actually I was thinking that the topic of corporate governance can be broadly analysed and used as the outlook is viewed from variety of scenes. But as I went through I found out that there was such difference and importance for banking sector in the moment of their opulence those years. Before I continue, what does corporate governance mean?

Many sources clarified that corporate governance is basically a participative actions by all members of organisation that must be involved in the firm to structure, direct, control and follow what are required to achieve its corporate objectives. That is why this system needs to be well developed in organization, specifically saying, in banking industry because this topic will analyse this further.

You can see the evidence when banking sector had high profit before tax (PBT) in 2006-2007, however what has happened to the next year? Success ‘in a flash’ became evil failure. A lot of banks in the world shut down their operations due to the lack of resources to preserve in 2008.  Some of them are Sanderson State Bank in Texas, Alpha Bank and Trust in Florida and even dozens of huge banks, HSBC and Lloyds Banking Group’s branches have closed.

On the other hand lately, Bankrate (2013) indicates that there were similar cases as Frontier Bank, Covenant Bank, 1^st Regents Bank and Westside Community Bank disappeared. I am aware that these are the evidences of ineffective banking corporate governance that reflected to the absence of agency model, transparency, risk management and responsibility towards the existing interests which are far more complicated than other business industries.

The challenges for outsiders are dense as they can’t actually see the real point inside the bank, likewise one example from Gregory Bell who used to work in Frontier Bank before it closed down. I think that as he did the bank fraud and money laundering, it opposed the bank to the 4 aspects mentioned in above. Risk management in there was not properly implemented, whilst the CEO of the bank hided the vital transactions of $20 million loans and attempted to illegally take $160,000 from it, which of course he did not accountable for the bank’s ‘going concern’ and definitely not into the interest of shareholders value (agency problem).

“Those responsible for bank failures were also ultimately responsible for the weakening of our economy,”- John Walsh, the USA’s counsel. If one bank affect this much how about if the rest do the same?

Considering this implication, the meaning of banking corporate governance should be working really hard because those results was affected upon the inappropriate coordination of BCG and thus may again, lead to the banking as well as global financial recession like that time. The remaining banks consequently have to make sure that in order to avoid this kind of worst disease, strategic decisions to make solid construction of relationship among owners or stockholders and stakeholders should be developed and carried out. Some of the schemes could be: one, the more practices from the top level of management towards the risks studies that will enable bank management to avoid immoral actions and quickly tackle the issue with backup strategies; two, adequate control system that get the most out of particular leverage; and three, provide adequate and firmed corporate structure along with its parameter so that word of power will never be misinterpreted.

So basically, enabling users’ right of entry to a complete information resource is strongly recommended in banking system because it may test professionals towards the key component of banking accountability and responsibility as well. However risks that may appear should be well-managed so that there is security to the information itself and it should be ensured that the security is met. Therefore, I believe that it will shift the access decisions in the course of the banking industry that can contribute to the sustainability of the banks, mainly the economy as the whole.