Firm value and share price strategy essay

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Firm value and share price strategy essay

Dividend Policy Theories Dividend Policy Theories Dividend policy theories are propositions put in place to explain the rationale and major arguments relating to payment of dividends by firms. Firms are often torn in between paying dividends or reinvesting their profits on the business.

Even those firms which pay dividends do not appear to have a stationary formula of determining the dividend payout ratio. Dividends are periodic payments to holders of equity which together with capital gains are the returns for investing in a firm's stock.


The prospect of earning periodic dividends and sustained capital appreciation are therefore the main drivers of investors' decisions to invest in equity. In this paper, we explore various theories which have been postulated to explain dividend payment behavior of firms.

Major Schools of thought: At the heart of the dividend policy theories discussion are two opposing schools of thought: One side holds that whether firms pay dividends or not is irrelevant in determining the stock price and hence the market value of the firm and ultimately its weighted cost of capital.

In retrospect, the opposing side holds that firms which pay periodic dividends eventually tend to have higher stock prices, market values and cheaper WACCs. The existence of these two opposing sides has spawned vast amounts of empirical and theoretical research.

Scholars on both sides of the divide appear relentless on showcasing the case for their arguments. Several decades since interest in the area was sparked off by Modigliani and Millerno general consensus has emerged and scholars can often disagree even on the same empirical evidence!

The arguments about dividend policy theory are so discordant in modern day research, that at least there is consensus with Black 's famous words who defined dividend policy as a puzzle: Their key premise is that to investors, payment of dividends is irrelevant as investors can always sell a portion of their equity if they need cash.

Therefore, two firms of the same industry and scale should have the same value even when one of the firms pays dividends and the other one does not.

School of Dividend Relevance Supporters of this theory argue that proposers of the dividend irrelevance theory made unrealistic assumptions in crafting their respective theories.

As such, they argue that if those assumptions, key of which are the absence of taxes and transaction costs, are relaxed, the dividend irrelevance theories won't be able to hold water.

Their main argument is that in a real world, payment of periodic dividends will have a positive impact on the stock price of a firm, its market value and its weighted average cost of capital. The ideals of this school of thought were solidified mainly by GordonLintner and Walter There are other subsidiary hypotheses which support the notion of dividend relevance.

The Modigliani and Miller Theorem Modigliani and Miller in rattled the world of corporate finance with the publication of their paper: They proposed an entirely new view to the essence of dividends in determining the future value of the firm.

As such, they argued that subject to several assumptions, investors should be indifferent on whether firms pay dividends or not. The paper was a sequel to the paper in which they argued that the capital structure of a firm is irrelevant as a determinant factor its future prospects.

The value of the firm is therefore dependent on the firm's earnings which result from its investment policy and the lucrativeness of its industry. When a firm's investment policy is known its industry is public informationinvestors will need only this information to make an investment decision.

Firm value and share price strategy essay

The theory further explains that investors can indeed create their own cash inflows from their stocks according to their cash needs regardless of whether the stocks they own pay dividends or not.

If an investor in a dividend paying stock doesn't have a current use of the money availed by a particular stock's dividend, he will simply reinvest it in the stock.

Likewise, if an investor in a non-dividend paying stock needs more money than availed by the dividend, he will simply sell part of his stock to meet his present cash need. Assumptions of the Modigliani and Miller model Modigliani and Miller pinpointed certain conditions which must hold for their hypothesis to be valid:The quality of the product also creates value (Singh 5).

Furthermore, product quality has a direct and positive influence on ROI, market share and price (Jacobson and David 32). Customers are willing to pay higher prices for higher quality.

Throughout the years, we have learned that markets are most efficient when the company is able to maximize at the current share price. Every company’s main goal should be to strive to maximize its value to every single one of their shareholders.

Share premium is the amount the stock is sold when the allocation price is more than par value. Merck calls these accounts on their GAAP balance sheet common stock and other paid-in capital. C. A pricing strategy is important to any firm in realising its corporate objectives, whether that be its sales revenue, market share or indeed profit, and thus there is much preoccupation within a business about its pricing strategy.

Firm value and share price strategy essay

Ultimately, this will be guided by many factors; not least the market power it has to set the price of its. Pricing is one of the most vital topic within the theory of Microeconomics. A firm can use a variety of pricing strategies to maximize its profit, gain market share, . If so, share price may not always be an accurate measure of the firm's value.

In an attempt to close this gap, managers may need to share their knowledge with outsiders so they can more accurately understand the real value of the firm.