Dividend Policy- Don't Rock the Boat

Dividend wealth is an interesting topic for conversation when it comes to rewarding shareholder investment.  My original thoughts on dividends were that such insignificant figures would make little difference regarding fluctuations.  This was before I was made to realise the scale of investment made in companies from insurance and pension funds.  It’s a crazy concept that the future of our retirement is massively dependent on the dividend policy of these huge companies.

There are arguments, when considering NPV that would recommend company profits would be better investing in ventures with a positive rating.  Such ventures would be claimed to raise the value of a company, thus boosting shareholder wealth.  Only residual cash left from profitable ventures would be repaid as dividends using this concept.

Modigliani & Miller echo such sentiments, claiming that dividend policy has no effect on company value.

In reality however, it can rarely be seen that dividend policy has no effect on company value.  Of course, in a ideal world where humans are rational, the understanding that dividends may be low due to a high level of invest activity which would boost their wealth.

Unfortunately, humans are very irrational and such fluctuations would likely lead to a mass exodus.  If several shareholder looked to sell their shares at the same time, the share price would fall.  Although M&M’s idea is theoretically true, in the real world dividends play a huge role.

Looking at the BP Gulf of Mexico oil spill, the announcement that BP would be halving their dividend payment resulted in panic from UK pension funds, fearing such a decrease could cost the UK millions in the long run.  Although not the only factor, BP’s share price suffered badly as a result of this announcement.

It can therefore be seen that shareholders, being the irrational, over-emotional being that they are crave stability.  A constant, un-fluctuating dividend yield is met favourably, thus companies have reacted to this by attempting to maintain a steady dividend payout, regardless of good or poor performance. 

Although investors may look on such a decision favourably, I would consider it a bit of a shame that shareholders are so insistent at focussing on their short term gains, that they cannot see the bigger picture- that maybe a company’s surplus cash could be put to better use, which would eventually lead to an increase in their own wealth.  To ask shareholder to think long term is quite possibly too much of a revolutionary step I fear. 

The Global Financial Crisis- A warning of things to come?

The start of my university life back in September 2007 coincided almost perfectly with the emergence of the dreaded credit crunch.  Walking down Northumberland Street to see countless people queuing outside of Northern Rock provided me with a great source of entertainment.  I saw it as a massive overreaction made by people that consider the scaremongering of the media to be gospel truth.  To an extent, I was correct; government policy protected the first £75,000 in a person’s bank account.  To actually learn the extent of the problems the economy faced on a global scale is quite terrifying, and utterly infuriating.

The level of confidence in the marketplace before the financial crisis was incredible.  The house market was booming, credit was cheap, and everything was rosy.  Collateralised debt obligations were a big source of this increased liquidity in the market, which promised a source of cash depending on the rating assigned by the credit rating agencies.  The rate of return in the AAA rated assets were so high, even banks were utilising these options.

Incredibly, these banks that were supplying long term mortgages were investing in assets that depended on the success of the mortgages they were issuing.  Confidence was so high in these assets, banks built up assets around these CDOs.  The problem arose when the house market began to decline, which saw the increase on defaults on mortgage payments.  All of a sudden, these ‘safe’ assets became far less secure. 

The cash shortages created a chain reaction that went on to cripple the banking sector, leading to panic amongst the public that their hard earned saving were at serious risk.  Suddenly cash became a rare commodity and successful businesses were finding it increasingly difficult to fund their operations as a result of this shortage.  The decision made by the UK government to offer a bailout option to the banks illustrates how severe the situation became, with the bailout dwarfing the annual cost of running the NHS.

The use of the word ‘confidence’ in this blog to describe the mood towards the marketplace is perhaps a poor choice.  Confidence implies a belief in the ability to succeed, yet the banks ability to succeed was so heavily hinged on the housing market and CDO’s, that the word ‘arrogance’ seems more appropriate.  The importance of planning, spreading risk and assuring cash is always available has been emphasised at every aspect of my business education.  How is it that bankers were so blind to this? 

The arrogance in assuming the bubble could never burst, that market value will continue to increase is beyond belief.  To not consider the possibility of a problem emerging in the future as a result of ‘putting all your eggs in one basket’ is madness.  To find a source of this particular financial crisis and focus on avoiding that particular mistake again is to miss to the point in my opinion however.

Maybe there will be greater regulation in future regarding the assumed security of investment assets, but in 10 years time, house prices will still demand staggering mortgages, banks will still take out loans to fund these mortgages and the world will run on the assumption that credit will be available to them to get by.

It is frustrating to think that we, the taxpayer are the victims in this financial crisis and I sincerely doubt we will ever get so much as a ‘thank you’ from Northern Rock or RBS.  It is scary to think that we appear to have applied a band aid to a broken leg in making no drastic changes to the regulations surrounding business.  Maybe we will learn from our mistakes and prosper from a more restrained credit system.  I worry however that we will continue to make the same fundamental mistakes in future.  Maybe the next time we see a credit crunch, the ramifications could be far more serious than public spending cuts and increases in tax.

Foreign Direct Investment

FDI- Foreign Direct Investment.

A long term investment that ideally acts as a mutually beneficial venture between the involved parties. In my eyes, FDI is the perfect concept of how capitalism should work. You go into a country and provide them with jobs, improve the standard of living of potentially thousands of people and boost the country's economy; in return you are given a benefits that could only be dreamed of in your home country. Sounds perfect.

Yet looking at the real life examples, this 'win/win' concept rarely seems to happen. On either side, there are examples of people taking advantage of each other. When you look at companies like Nike, the sweatshops that have been discovered show a capitalisation on a workforce that are treated hugely unethically. There is a fine line between co-operation and taking advantage of each other. Far too often, we see this being the case. Nike being one a a long, long list of companies that have been exposed as to treating this foreign workforce as slaves.

On the other hand, there are examples that can be seen from the World Investment Report that shows an ever increasing investment in developing countries. When you the the benefits that China and India have experienced, and in turn, the positive impact that companies and consumers all over the world have experienced as a result of effective FDI, you can see that it is a brilliant concept.

The reasonable cost of the goods that we can purchase in this country are a direct result of these companies taking advantage of these clear and obvious benefits of things such as transport costs, avoiding export constraints in the case of the European Union, the 'win/win' can be massive.

The shame is when you see the countries that are in such dire need of trade, such as Africa that are being ignored. In a perfect world, I would love to see these countries utilised more in future. The capitalist dream needs to be expanded to benefit more areas to capitalise on more trade opportunities and improve the standard of living of people that are struggling to survive. FDI in these areas could be the key to this.