Corporate Issuers
Dutch Auction
-A method of issuing securities (common stock) by which investors place bids indicating how many shares they are willing to buy and at what price -The price the stock is then sold for becomes the lowest price at which the issuing company can sell all the available shares.
Constant Dividend Payout Policy
-a company applies a target dividend payout ratio to current earnings -this makes the dividends more volatile than a stable dividend policy
Stable Dividend Policy
-a company tries to align its dividend growth rate to the company's long-term earnings growth rate -dividends may increase even in years when earnings decline -dividends will increase at a lower rate than earnings in boom years = (Expected Earnings * Target Payout Ratio - Previous Dividend) * Adjustment Factor
Stock Dividends
-accounted for as a transfer of retained earnings to contributed capital -stock dividend will decrease the price per share -since all shareholders get the same amount, the proportionate ownership would not change post stock dividend
MM Theory
-aka Miller and Modigliani's Dividend Theory -argues that given perfect markets, dividend policy is irrelevant -corporate dividend policy is irrelevant because shareholders can create their preferred cash flow stream by selling the company's shares, aka homemade dividends -assumes no taxes or transaction costs
Types of Influential Owners
-banks -families -sovereign governments -institutional investors -group companies -PE firms -foreign investors -managers -board directors
One-Tier Board
-board that consists of a single board of directors -it is composed of executive (internal) and non-executive (external) directors
Two-Tier Board
-board that consists of a supervisory board that oversees a management board
Split-Rate Taxation Systems
-corporate profits are taxed at different rates depending on whether the profits are retained or paid out in dividends
Materiality
-defined by both size and fit -rule of thumb for size is that large actions are those that are greater than 10% of an issuer's enterprise value -fit refers to the alignment between the action and an analyst's expectations for the issuer
Early Warnings Signs if a Company can pay Dividends
-dividend coverage ratio -the level of dividend yield -whether the company borrows to pay the dividend -the company's past dividend record
Double Taxation Systems
-dividends are taxed at both the corporate and shareholder level
Primary Challenges of Integrating ESG Factors into Investment Analysis
-identifying and obtaining information that is relevant, comparable, and decision-useful -information and metrics are reported inconsistently and voluntarily by companies
Different Tax Rates Theory
-in countries where dividends are taxed at higher rates than capital gains, taxable investors prefer that companies reinvest earnings in profitable growth opportunities or repurchase shares, so they receive more of the return in the form of capital gains
Equity vs Fixed Income Valuation of ESG Factors
-in equity analysis, ESG integration is used to both identify potential opportunities and mitigate downside risk -in fixed income analysis, ESG integrations focuses on just mitigating downside risk
Divestment Actions
-includes sales and spin offs -these actions are often made by issuers seeking to increase growth or profitability or reduce risk by shedding certain divisions and assets
Restructuring Actions (not Investment or Divestment)
-includes: -cost cutting -balance sheet restructurings (sales-leaseback) -reorganizations (court-supervised) -these actions so not change the size or score of issuers but are aimed at improving returns on capital to historical or peer levels
Investment Actions
-includes: -equity investments -joint ventures -acquisitions -these actions are often made by issuers seeking growth, synergies, or undervalued targets
Restructurings
-includes: -investment actions that increase the size and scope of an issuer's business -divestment actions that decrease size or scope of an issuer business -restructuring actions that do not affect scope but improves performance
Factors that Influence Dividend Policy
-investment opportunities for the company -volatility in its future earnings -financial flexibility -tax considerations -flotation costs -contractual and legal restrictions
Bird in Hand Theory
-investors value a dollar of dividends today more than uncertain capital gains in the future
Vertical (Pyramid) Ownership
-involves a company or group that has a controlling interest in 2 or more holding companies, which in turn have controlling interests in various operating companies
Horizontal Ownership
-involves companies with mutual business interests that have cross-holding share arrangements with each other
Value of Share Repurchase
-it is equivalent to the payment of a cash dividend of equal amount in its effect on total shareholders' wealth -if the buyback market price per share is greater (less) than the book value per share, then the book value per share will decrease (increase) -share repurchases can be a positive signal because the company thinks their share are undervalued, but they can also a negative signal because the company has few potential investment opportunities
Principal-Agent Problem
-occurs when the conflict is between shareholders and management
Principal-Principal Problem
-occurs when the conflict is between the controlling shareholders and the minority shareholders
Why Share Repurchase over Cash Dividends
-offers company management more flexibility than cash dividends by not establishing the expectation that a particular level of cash distribution will be maintained
Concentrated Shareholder Ownership
-ownership that reflects an individual shareholder or a group (controlling shareholders) with the ability to exercise control over the corporation -controlling shareholders may be either majority shareholders or minority shareholders
Dispersed Shareholder Ownership
-ownership that reflects the existence of many shareholders, none of which, either individually or collectively, has the ability to exercise control over the corporation
Conflicts of Dividends
-payment of dividends can reduce the agency conflicts between managers and shareholders -paying dividends can also worsen conflicts between shareholders and debtholders
Dividend Declarations Impact on Investors
-provide confidence in the prospects of the company -initiating a dividend is a positive signal, whereas cutting/omitting a dividend is typically a negative signal -regular dividend payments are seen as a measure of investment quality
Materiality in ESG Context
-refers to ESG-related issues that are expected to affect a company's operations or financial performance and the valuation of its securities
Dividends can take the form of
-regular or irregular cash payment, stock dividends, or stock splits -only cash dividends are payments to shareholders -stock dividends and splits just carve equity into smaller pieces and do not create wealth for shareholders
Regular Cash Dividends
-represent a commitment to pay cash to stockholders on a quarterly, semiannual, or annual basis -this is different than irregular cash dividends -cash dividend will decrease the price per share by that amount, all things equal
Share Repurchases thru Cash vs Borrowed Funds
-share repurchases made with cash have the potential to increase EPS =share repurchases made with borrowed funds can increase, decrease, or not affect EPS depending on the company's after-tax borrowing rate and earnings yield
Share Repurchases vs Tender Offers
-share repurchases normally happen in the open market -tender offers occur at a fixed price or price rage (normally a premium) through a Dutch auction -shareholders who do not tender increase their relative position in the company -> direct negotiations with major shareholders do not typically happen because if they sell their shares, it could value for the remaining stockholders
Tax Imputation Systems
-shareholders receive a tax credit on dividends for the tax paid on corporate profits
Dual-Class (Multiple-Class) Shares
-shares that grant 1 or more share classes superior or even sole voting rights while other share classes have inferior or no voting rights
Bottom-Up Drivers of Costs of Capital
-stability -profitability -leverage -asset specificity
CEO Duality
-this exists when the CEO also serves as a chairperson of the board
Reverse Stock Splits
-usually occur after a stock has dropped to a very low price -similar to normal stock splits, this does not affect shareholder wealth
3 General Theories on Investor Preference for Dividends
1. MM theory 2. Bird in Hand theory 3. Theory relating to tax rates
3 Common Valuation Methods for Companies Involved in Corporate Restructurings
1. comparable company 2. comparable transactions 3. premium paid analysis
Evaluation of a Corporate Restructuring
1. initial evaluation 2. preliminary evaluation 3. modeling 4. updating the investment thesis -all 4 steps are generally only done for material restructuring
3 Main Sources of Information for ESG Factors
1. proprietary research (annual reports, proxy reports, etc.) 2. ratings and analysis from ESG data providers 3. research from not-for-profit industry organizations and initiatives
WL Corporation is located in a jurisdiction that has a 40% corporate tax rate on pretax income and a 30% personal tax rate on dividends. WL distributes all its after-tax income to shareholders. What is the effective tax rate on WL pretax income distributed in dividends? 42%. 58%. 70%.
58%
Initially the two sisters owned all the shares of Ouse Inc., but two years ago they implemented performance-based compensation for the top five senior managers, and as part of this process, the managers now own a combined 10% of the equity. The change in ownership structure that occurred two years ago most likely addressed which of the following issues associated with family-owned businesses? Poor transparency Interlocking directorships Ability to attract quality management
Ability to attract quality management Ouse was initially a family-owned business, owned by Catherine Ferguson and her sister, which can make it difficult to attract quality talent for management positions. However, the implementation of a performance-based compensation plan two years ago would improve the motivation and rewards available to management and make it easier to attract quality talent. B is Incorrect. Interlocking directorships can be a problem in family-owned businesses when there is a corporate group controlling several corporations. There is no mention here of other related companies.
The founding family owns 55% of the outstanding shares. Each ownership share has equivalent voting rights. The board of directors of BR Hotels consists of 15 members, with independent CEO and chairperson roles. The board includes one independent member and two women, and 20% of the board members have experience in the hotel industry. The potential conflict between or among shareholders and managers of BR Hotels can best be described as: voting caps. a principal-agent problem. a principal-principal problem.
C BR Hotels has concentrated ownership, given that the family owns 55% of the shares. It also has concentrated voting power, since each ownership share has equal voting rights. In this ownership structure, the controlling shareholders have power over both management and minority shareholders. The controlling shareholders are referred to as strong shareholders and the managers as weak managers. The conflict in this structure exists between the controlling shareholders and the minority shareholders. The controlling shareholders can potentially divert resources for their own benefit at the expense of the minority shareholders. This conflict is referred to as a principal-principal problem.
She asks Yorkton to identify ESG factors impacting Titian and estimate the equity valuation for the company. Yorkton uses proprietary methods to identify the ESG factors. The potential problem with Yorkton's approach to identifying ESG factors is the: promotion of uniform accounting standards. subjective assessment of ESG scores and rankings. inconsistent reporting of ESG information and metrics among firms.
C Yorkton uses the proprietary method to identify company and industry ESG factors. This approach relies on using company-specific ESG data that is publicly available from annual reports, proxy reports, corporate sustainability reports, and regulatory filings such as the 10-K. The problem is inconsistent reporting of ESG information and metrics among firms. The level of disclosure also varies considerably among companies because ESG-related disclosures are voluntary. This creates comparability issues for analysts.
Beta Corporation is a manufacturer of inflatable furniture. Which of the following scenarios best reflects a stable dividend policy for Beta? Maintaining a constant dividend payout ratio of 40-50%. Maintaining the dividend at US$1.00 a share for several years given no change in Beta's long-term prospects. Increasing the dividend 5% a year over several years to reflect the two years in which Beta recognized mark-to-market gains on derivatives positions.
Choice B Choice A is consistent with a constant dividend target payout ratio policy. Choice C is not correct because the earnings increases described are not sustainable long term.
The payment of a 10% stock dividend by a company will result in an increase in that company's: current ratio. financial leverage. contributed capital.
Contributed Capital A stock dividend is accounted for as a transfer of retained earnings to contributed capital.
A company has positive free cash flow and is considering whether to use the entire amount of that free cash flow to pay a special cash dividend or to repurchase shares at the prevailing market price. Shareholders' wealth under the two options will be equivalent unless the: company's book value per share is less than the prevailing market price. company's book value per share is greater than the prevailing market price. tax consequences and/or information content for each alternative is different.
Option C
Stranded Assets
assets that have suffered from unanticipated or premature write-downs, devaluations or conversion to liabilities
Ferguson is very interested in being associated with an SRI fund and asks how Ouse could qualify for the investment. Malik explains that the private equity fund he is thinking of uses data provided by the company and looks for other information from industry organizations, news reports, and environmental groups. Which of the following approaches to identifying a company's ESG factors best describes the one used by the private equity fund that Malik mentions? ESG data providers Proprietary methods Not-for-profit initiatives
Proprietary methods The private equity fund is using proprietary methods to identify and assess ESG investments. Proprietary methods include analysts using their own judgement based on information available from corporate reports, industry organizations, news reports, and environmental groups.
2013 2014 2015 2016 EPS $1.38 $1.39 $1.37 $1.44 DPS $0.20 $0.22 $0.22 $0.22 Based on Exhibit 1, Avignon's current dividend policy is best described as a: residual dividend policy. stable dividend policy. constant dividend payout ratio policy.
Stable Dividend Policy Avignon's current dividend policy would be classified as stable because it has paid the same amount for the past three years regardless of earnings volatility.
The distribution of cash among shareholders is equivalent to what would have otherwise been distributed to them as dividends. Share repurchases provide greater flexibility to management than the payment of cash dividends. When directly negotiated, share repurchases can be used to purchase stock for less than the current market price. Which of Lee's statements to Carlyle about share repurchases is least accurate? Statement 1 Statement 2 Statement 3
Statement 1 Although the amount of cash distributed is the same, only those shareholders who have their shares purchased by the company will receive any cash.
Estimated Conglomerate Discount
Total Estimated EV - Current Trading EV