Dividend Policy and Corporate Governance
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Questions and Answers

What is the formula to calculate the Retention Rate (RR)?

  • RR = 1 - Payout Rate (correct)
  • Payout Rate = Dividends / Net Income
  • RR = 1 + Payout Rate
  • RR = Dividends / Total Earnings

    • What might indicate financial difficulties for a company?

  • Increase in dividend payments
  • Dividend cut (correct)
  • High dividend yield
  • Stock repurchase

    • Which of the following is considered an alternative to dividends for distributing cash?

  • Stock repurchase (correct)
  • Bond issuance
  • Capital restructuring
  • Interest payments

    • What does Dividend Yield measure?

    <p>The return derived from dividends alone</p> Signup and view all the answers

    What percentage of all boards in the US are comprised of independent directors?

    <p>62%</p> Signup and view all the answers

    What reflects the balance of interests in Corporate Governance?

    <p>Shareholders, management executives, customers, and community</p> Signup and view all the answers

    Which role is primarily responsible for linking the board and upper management?

    <p>Chairman</p> Signup and view all the answers

    What is often a reason for firms to cut dividends?

    <p>To reinvest in business opportunities</p> Signup and view all the answers

    What percentage of mergers are estimated to fail, according to KPMG's study on global acquisitions?

    <p>80%</p> Signup and view all the answers

    What factor primarily determines who gets the benefits of synergy in an acquisition situation?

    <p>Whether the bidding firm's contribution is unique or easily replaceable</p> Signup and view all the answers

    What is one reason that synergy is difficult to achieve in acquisitions?

    <p>They often overestimate the cultural compatibility of firms</p> Signup and view all the answers

    In a cash acquisition, how does the NPV calculation differ from a stock acquisition?

    <p>The cash cost is explicitly included in the NPV formula</p> Signup and view all the answers

    Which type of M&A is characterized by cooperation with the management of the target firm?

    <p>Friendly takeover</p> Signup and view all the answers

    Which of the following best describes 'poison pills' in the context of defensive tactics in M&A?

    <p>Shareholder rights plans that make a company less attractive to hostile bidders</p> Signup and view all the answers

    What is a key risk associated with M&A during the integration phase?

    <p>Disruption of ongoing operations due to integration issues</p> Signup and view all the answers

    How do target stockholders benefit in a situation with multiple bidders involved in a takeover?

    <p>They typically walk away with the bulk of the gains</p> Signup and view all the answers

    In a stock acquisition, what factor is critical to determine the overall cost of the acquisition?

    <p>The number of shares given to target stockholders</p> Signup and view all the answers

    What is a significant concern labeled as 'Winner's Curse' in the context of M&A?

    <p>The acquiring company may overestimate the value of the target firm</p> Signup and view all the answers

    What is the primary disadvantage of a forward contract?

    <p>Potential for default</p> Signup and view all the answers

    What is a key characteristic of futures contracts compared to forwards?

    <p>Traded on an exchange</p> Signup and view all the answers

    How does a farmer profit from selling a short position in soybean futures?

    <p>By selling the crop at a predetermined price</p> Signup and view all the answers

    What does revenue enhancement in M&A typically aim to achieve?

    <p>Improved advertising effectiveness</p> Signup and view all the answers

    Which of the following is NOT a way M&A can reduce costs?

    <p>Inefficient resource allocation</p> Signup and view all the answers

    What is the expected outcome of a merger that primarily aims for diversification?

    <p>No effect on combined value</p> Signup and view all the answers

    What may happen with cash slack in a merger?

    <p>Opportunities may be rejected due to capital issues</p> Signup and view all the answers

    How can tax benefits arise from an M&A situation?

    <p>Through unused tax credits from a losing firm</p> Signup and view all the answers

    What is the main indicator of synergy after a merger?

    <p>Outperformance relative to competitors</p> Signup and view all the answers

    In the context of mergers, how is synergy defined?

    <p>Combined value greater than the sum of individual firms</p> Signup and view all the answers

    What merger-related situation is described when firms realize cash benefits from joint operations?

    <p>Valuing Cash Slack</p> Signup and view all the answers

    What aspect of M&A affects capital requirements?

    <p>Availability of investment opportunities</p> Signup and view all the answers

    Which of the following is a disadvantage of an acquisition in terms of valuing synergy?

    <p>Overvaluation of revenue strengths</p> Signup and view all the answers

    According to empirical evidence, a successful merger should result in what average increase in value?

    <p>7.48%</p> Signup and view all the answers

    What is one potential effect of managerial entrenchment?

    <p>Larger compensation demands from managers</p> Signup and view all the answers

    What is the primary role of the Governance Committee in a corporate structure?

    <p>To assess and recruit board members</p> Signup and view all the answers

    Which committee typically meets seasonally, correlating with the end of the fiscal year?

    <p>Audit Committee</p> Signup and view all the answers

    What approach is suggested to reduce managers' control over future dividends?

    <p>Implement significant debt obligations</p> Signup and view all the answers

    What is a feature of 'Superstar CEOs' as analyzed by Malmendier and Tate?

    <p>More earnings management after receiving awards</p> Signup and view all the answers

    What is the main motivation behind the implementation of the Sarbanes–Oxley Act (SOX)?

    <p>Respond to corporate scandals and improve investor confidence</p> Signup and view all the answers

    What is an example of a strategy used for managerial entrenchment?

    <p>Implementation of golden parachutes</p> Signup and view all the answers

    What can be considered a cost of the Sarbanes–Oxley Act (SOX) for companies?

    <p>0.04% of firm's revenues</p> Signup and view all the answers

    Which of the following describes a characteristic of diversified firms regarding their boards?

    <p>They have larger and more independent boards</p> Signup and view all the answers

    In risk management, what is the first step in the process?

    <p>Identify important fluctuations</p> Signup and view all the answers

    What does the term 'forward contract' refer to?

    <p>An agreement to buy or sell an asset at a future date</p> Signup and view all the answers

    What is the consequence of firms having higher monitoring costs?

    <p>They tend to form larger boards</p> Signup and view all the answers

    What is one potential issue resulting from conflicts of interest within firms?

    <p>Self-serving cash-flow diversions</p> Signup and view all the answers

    What is a key focus of the Finance Committee?

    <p>Development of annual budgets</p> Signup and view all the answers

    What is one of the main elements established by the Sarbanes–Oxley Act?

    <p>Standards for auditor independence</p> Signup and view all the answers

    Which of the following represents a risk management tool used to mitigate fluctuations?

    <p>Hedging</p> Signup and view all the answers

    Study Notes

    Dividend Policy

    • Retention Rate (RR) = 1 - Payout Rate
    • Firms are reluctant to cut dividends
    • Higher dividends mean less internal cash for investment.
    • Dividends aren't the only way to distribute cash; stock repurchases are an alternative.
    • Stock repurchases are popular due to tax advantages and shareholder preferences.
    • Dividend payout measures the percentage of earnings paid out as dividends.
    • Payout Rate = Dividends / Net Income
    • A dividend cut is often a signal of trouble.
    • Tax shield and dividend taxes affect dividend policy.
    • Dividend Yield = Dividends / Equity Value; measures the return from dividends alone.
    • In a perfect market with no taxes, dividend policy is irrelevant.

    Corporate Governance

    • Corporate Governance is a system of rules, practices, and processes to direct and control a firm.
    • Corporate Governance balances the interests of shareholders, management, customers, and the community.
    • Board of Directors have 10 key roles:
      • Selecting, monitoring, evaluating, and compensating senior management.
      • Ensuring adequate management succession planning.
      • Reviewing and approving significant corporate actions.
      • Reviewing and approving operating plans and budgets.
      • Monitoring corporate performance.
      • Reviewing financial controls.
      • Reviewing and approving financial statements.
      • Reviewing ethical standards and legal compliance.
      • Overseeing enterprise risk management.
      • Monitoring shareholder, employee, and community relations.
    • The Chairman is the presiding officer of the board, and might be the CEO.
    • Other board members choose the Chairman.
    • The Chairman ensures the firm fulfills its duties to shareholders and acts as a link between the board and upper management, and represents the company externally.
    • Independent directors have no material or pecuniary relationship with the company.
    • 62% of US boards are composed of independent directors.
    • NYSE and NASDAQ mandate over 50% independent directors.
    • Independent oversight is not guaranteed.
    • CEOs may influence independent directors.
    • The Executive Committee facilitates quick decisions between regular meetings.
    • The Audit Committee meets seasonally, often at the end of the fiscal year.
    • The Governance Committee focuses on board recruitment and assessment.
    • The Finance Committee manages the annual budget.
    • The Program Committee oversees long-range planning.

    Conflicts of Interest & Managerial Entrenchment

    • Conflicts of interest can arise from self-serving cash flow diversions and managerial entrenchment.
    • Private benefits of control can stem from managerial decisions benefitting managers at the expense of other stakeholders.
    • Jensen (1986) analyzed these issues.
    • Payouts reduce resources under managers' control.
    • Firms may grow beyond optimal size due to manager incentives.
    • Growth increases managerial power, potentially in firms with substantial free cash flow (FCF).
    • A commitment problem arises from managers promising permanent dividend increases but potentially changing their minds.
    • Debt can be a substitute for dividends to bond payment promises, as CEOs must pay debt holders to avoid bankruptcy.
    • Shleifer and Vishny (1989) analyzed managerial entrenchment.
    • Managers might make manager-specific investments, making replacements more costly and less likely.
    • Higher future compensation may be demanded by entrenched managers.
    • Entrenchment can involve investments in assets that have more value with the current CEO, even if not value-maximizing.
    • This is an issue when managers hold little equity and shareholders are dispersed.
    • Golden parachutes, anti-takeover devices, are managerial entrenchment strategies.

    SOX Act & Corporate Scandals

    • The Sarbanes-Oxley Act (SOX) expanded requirements for US public companies.
    • SOX addresses boards, management, and accounting following corporate scandals like Enron and WorldCom.
    • Core elements: external auditor independence, senior executive responsibility for financial reports, and enhanced reporting, including off-balance sheet transactions.
    • It establishes criminal penalties for tampering with financial records or investigations.
    • Prior to SOX, auditing forms were largely self-regulated.
    • SOX is estimated to cost 0.04% of a firm's revenues.
    • SOX can reduce borrowing costs (50-150 bps).
    • SOX section 806 protects whistleblowers from retaliation.

    Risk Management

    • Volatility is a classic risk measure.
    • Diversification costs, distress, and financing can be affected by overall volatility.
    • Risk management tools include hedging (reducing exposure to fluctuations).
    • Financial hedging uses derivatives (claims on other assets).
    • Operational hedging uses decisions to manage risk.
    • The risk management process includes identifying fluctuations, assessing a firm's/portfolio's risk profile, defining tools, considering availability and cost, and accounting for employee time.
    • Risk profiles are graphed showing price changes relative to value changes. Steeper slopes mean higher exposure and potential need for hedging.
    • Forward contracts are agreements to exchange an asset for a set price (long = buy, short= sell). They are customizable but can have liquidity and default issues.
    • Futures contracts are standardized forward contracts traded on exchanges (e.g., CME crude oil futures).

    Mergers and Acquisitions

    • Mergers and acquisitions (M&A) can affect incremental free cash flows (FCF) by influencing revenues, costs, taxes, and capital requirements.
    • Revenue enhancement can come from improved advertising, stronger distribution, market power, and reduced financial constraints.
    • Cost reduction from M&A includes economies of scale and supply chain pricing power.
    • Tax benefits arise from unused tax credits and income tax savings from mergers.
    • Capital needs can be impacted by capital synergies.
    • Synergy is the incremental value from a merger, calculated as the difference between the combined firm's value with and without synergy.
    • Diversification does not inherently create value.
    • Cash slack can create value in a merger, as the cash-rich firm can finance projects in the cash-poor target firm.
    • Tax benefits can stem from using net operating losses (NOLs) from one firm in a merger for tax savings with the other.
    • Synergy is often a "plug" variable, valued with incomplete, cursory valuations.
    • Common errors involve valuing only the target company, ignoring delivery costs, underestimating organizational integration.
    • Acquisition methods: cash or stock offers.
    • Cash vs stock acquisitions differ in gain sharing among shareholders and tax implications.
    • Cash acquisitions don't dilute control or reflect overvalued stock.
    • A hostile takeover involves strategies like toe-holds, bear hugs, open-market purchases, and proxy fights, possibly leading to tender offers.
    • Defensive tactics may include corporate charters, poison pills, and leveraged buyouts.
    • M&A risks include overpayment to the target, integration issues, managerial resource concerns, and continued subsidization of sub-optimal groups.
    • Empirical evidence shows mixed success, in some cases M&A leads to a significant increase in value, but most fail to create value for shareholders.

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    Description

    This quiz covers essential concepts of dividend policy and corporate governance, focusing on key metrics like retention rate, payout rate, and dividend yield. It highlights the importance of balancing stakeholder interests and the role of the Board of Directors. Test your understanding of these critical financial and managerial concepts.

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