Iycee Charles de Gaulle Summary Financial Management Essay

Financial Management Essay

Financial Management

1. IntroductionFinance

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    This paper seeks to accomplish the following for Kingfisher plc whose stocks are quoted on the London Stock Exchange:

a         To comment upon the company’s dividend policy (Van Horne, 1992) over the last few years;

b        To calculate correlation coefficients between the share price performance and dividends over the same period;

c         To briefly describe my individual role in completing the assignment and reflect on what I have learned from the exercise.

2. Analysis and Discussion

2.1 Comment upon the company’s dividend policy over the last few years

       As per verification from company’s website Kingfisher’ dividend policy for the last few years is a regular cash dividend (Ross, Westrerfield, Jordan (1996) declaration given to stockholders which allows also scrip dividend conversion until June 2005.  Under such option dividend conversions which were replaced in 2005 by a dividend reinvestment plan (DRIP), UK stockholders are essentially offered to reinvest their dividends. It’s an act of putting back money into the corporation allowing management to use further the funds for more and better business opportunities.  For both the scrip dividend and the DRIP, retained earnings of the corporation are effectively capitalized. The effect therefore of such policy is to increase corporate capitalization. This policy is also a matter of corporate strategy.  A corporate strategy is a plan to attain a corporate objective.  As to what is the corporate objective, such will usually include an economic and non-economic objective.  In this particular assignment, the objective most probably refer to financial or economic objective.  The financial objective is to maximize the stockholders wealth. As to how this will be accomplished is a function of the stock price maximization (Weston, Brigham, 1993). Hence, our premise is that the higher the stock price the better for the corporation since higher stock means better value for the investment (Holmes, 1998) of the owners or stockholders.  To establish whether the strategy (Porter, 1980)  of adopting a dividend policy therefore is to determine whether or not it increases the stock price of the corporation as reflected in the stock exchange.  This issue will be addressed by answering the next question in the next question.

        As to why Kingfisher plc changed its policy from scrip dividend up until 2005 to DRIP at present, there is a need to know to know first that a scrip dividend is “a scrip issue made in lieu of a cash dividend” (Pietersz, 2006). Under such terms, shareholders are given the option “to choose whether to receive a cash dividend or shares.” (Pietersz, 2006).  After knowing what is a scrip dividend, how is it different from a DRIP then?  Pietersz, (2006) that a scrip dividend is preferable for shareholders to a DRIP as it avoids dealing costs, and the number of shares received is known at the time the election to receive shares rather than cash is made.  The same author then explained that in the case of a DRIP the number of shares bought will depend on the share price on the day of the purchase itself. There is therefore a difference as to knowledge of the number of shares a time of the decision to receive over that of cash.  From the point of view therefore of management, it is again more strategic to use DRIP over scrip because stockholders will literally know only the price at the time of purchase. This could in sense insure the reinvestment of the dividend once the election was made and the and it would much harder for the stockholder to back out. Viewed from the advantage to the corporation more funds will be generated for investment purposes.  As to the effectivity of DRIP, it will still need to be proved empirically because there is still no data to compare with since it is essentially knew.

        For an ordinary decision maker to know what really happen in availing a scrip issue in terms of theoretical explanation, Pietersz (2006) has much to share about the issue.  The author thus further described that a scrip issue (also called a capitalization issue or a bonus issue) as “the issue of new shares to existing shareholders at no charge pro rata to their existing shareholdings.”  The author thus convincingly explained that that the term “capitalization issue” is less common but more accurate than the terms scrip or bonus issue as it reflects what happens in the books of the company. Pietersz (2006) said: “The share capital (on the balance sheet) has to increase by the nominal value of the newly issued shares, this is provided by an equal decrease in another part of the shareholder’s funds – for example the profit and loss (Churchill, Jr., 1995) item on the balance sheet (Meigs and Meigs,1995) or a re-valuation reserve. This is capitalization.” He further explained: “A bonus issue moves money from one account that belongs to the shareholders to another account that belongs to the shareholders. It is therefore basically a bookkeeping exercise and the value of a shareholding would be the same before and after a bonus issue despite the increase in the number of shares held. Share price charts and other comparisons should be adjusted for the bonus issue. For example if a 1 for 5 bonus issue has taken place prices from before the share went ex-bonus should be adjusted by multiplying by 5/6 in order to make them comparable with the current price.”

         It must be pointed out however that in both cases there is reinvestment of funds to the corporation and if it will be shown that doing stock policy increases stock price then such is good dividend policy. The reality of the similarity of reinvestment of funds is also confirmed by Pietersz, G.  (2006) when he said that from the point of view of a shareholder the DRIP is similar to receiving a scrip dividend, some important differences include the fact that (1) A DRIP does not retain cash within the company; (2) There are dealing costs; and (3) The number of shares a shareholders gets depends on the price on the day on which the DRIP operator purchases the shares.

      It must not be therefore surprising also to know why Kingfisher uses the scrip dividend as part of capitalization issue. It obvious that the objective (Blair, 1996) is to influence the prices of its stock, which will tell whether it is satisfying stockholders (Wallace, 1998) interest by increasing their wealth (Thurow , 1999). This inference may actually be turning to be theoretically sound as confirmed by Pietersz, (2006) when it explained that despite preservation of the value of the shares before and after the capitalization issue (Berger, et. al., 2000) , the event can really have an impact on the share price for two reasons.  First is the gesture of confidence; such will reduce the amount available to pay dividends – therefore the management (Thompson and Sheldon, 2003) of a company is sure that the amount capitalized will not be needed to pay dividends. Second, it can improve the liquidity (Voss, 1992) of very high priced shares – i.e. if the old share price was so high as to make trading (Moser J., 1994) of small blocks awkward. (Paraphrasing made)

2.2 Calculate correlation coefficients between the share price performance and dividends over the same period.

      As per result computation using Microsoft Excel, correlation coefficient between the share price, as dependent variable and the scrip dividends, as independent variable,  is 0.924666.  Please See table I below.  The correlation shows that there is a positive correlation between the stock-price and dividends for the years 1999 to 2005 which may indicate that the behaviour of stock price has been influence by the company’s dividend policy.   The correlation coefficient is almost close to 1. Hence, it could mean as the Kingfisher company jacks up  annual scrip dividend its stock price follow as a result  and necessarily any decline in the annual scrip dividend it decline in the average annual stock price will follow suit.  This may therefore explain the company’s adoption of the DRIP which is expected to increase reinvestment.

     The basis of average stock market price of stock which is computed by adding all the stock prices under the “HIGH” column and dividing each year by the actual number of trading days (Moser, 1994) with in the year.  The use of HIGH price is an approximation. Other prices could also be used which may yield equally the same result.

Table I

Appendix A- Computation of  correralation coefficient
Kingfisher. Com

Average

Annual
Market

Scrip

Dividend
Stock

1999

1398.2
535.66

2000

1198.05
383.62

2001

895.45
312.70

2002

298.7
248.07

2003

431.8
256.37

2004

556.3
292.20

2005

306.45
256.84

Correlation coefficient =
0.924666

Conclusion

       Deciding wither to give or not to give dividends to stockholders.  Deciding what from of dividends is a strategy.  Such decisions are we call the application of a dividend policy. Taking Kingfisher as an example made the analysis so real since the company is an existing company whose stocks are listed in the London Stock Exchange (2006). One could actually that corporate decisions are so real.  Textbooks do confirm the existence of a dividend policy which a part of the overall finance objective of profit maximization (Samuelson & Nordhaus, 1992). But first the policy that bring up the prices of its stock which measures the attainment of wealth maximization as an objective.

      With data actually taken from Kingfisher’s website, we have more confidence to use them from which we determine if there was a significant relationship between the amount of dividend and the stock price of the company.  Such knowledge would tell a responsive decision maker that if the Kingfisher would like to increase to stock price, it would do so by encouraging reinvestment which is doable under a scrip dividend or a DRIP. It is the very that the corporation is doing and it would seem it is doing good for the company

       With the proven disadvantage of scrip dividend to that of DRIP on the point of stockholders, such may actually mean more advantages to Kingfisher. For doing so, it must be strategic for Kingfisher. Starting June, 2005, Kingfisher offered a dividend re-investment plan in lieu of the scrip and it must be doing the decision for a purpose.  Pietersz, G.  (2006)  agree when he said: “A dividend re-investment plan (DRIP) is a means of allowing shareholders to re-invest their dividends in the purchase of more shares in a company. The operator of the DRIP (typically the company’s registrars who maintain the register of shareholders) pools the cash dividends payable to shareholders who have chosen to use the DRIP, purchases shares in the market and allocates them to the shareholders.” It is believed that Kingfisher is doing this to further increase stock price. Based on positive correlation coefficient and the analysis made, Kingfisher may appear to attain its objective more.

Individual Preparation

Briefly describe your individual role in completing the assignment and reflect on what you have learned from the exercise.

      This assignment gave me a rather challenging role. Since one cannot do this with research, I for one must do my best for the group. With the ease of using the Internet, did found some relevant materials which I further pursued thru further reading the textbooks and references

        I came to see and analyze materials about accounting finance and before I know it I was responding to the questions asked in the assignment.  Communicating with the group did help each us for ideas and insights came out as we talked about the assignment.

    To say that I have learned few in this would be an understatement.  I came to realize that management decision could be as diverse or strategic.  Things there in the board have so much responsibility even in their policies on dividends. Dividend policy was actually one of the things that I learned but at the same time I was asking myself if dividends would just be reinvested back into the corporation what is then the benefit of the stock holder that he could enjoy at the moment?  I came to know that there is beauty in just keeping the investment to grow and grow and that higher stock prices would also solve the problem because the investor could always sell his or stock in the marker and once decision to allow reinvestment could actually now be recovered in terms of higher stock price.

     There is this wisdom for a company to distribute earnings regularly through cash dividends (Brigham and Houston, 2000) but give the option to the stockholder to reinvestments their funds through the scrip dividend of the dividend reinvestment plan (DRIP). Such kind of dividend policies may turn to be increasing the profitability of the business in addition to the greater opportunities for more business and more strategically with bringing the stock price up for the company. Learning the application of the formula in correlation coefficient is a great lesson to remember. With two variables, one independent variable (Montgomery, 2001) and the other a dependent variable, one would be able to make prediction.

     The use of Kingfisher whose stocks are listed in stock exchange really made our experience so real. We felt that that although we are just students, we had the chance know the chance to observe and criticise what these tough guys are doing in the real business world making corporate decisions.

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