The logic is as follows a firm that pays a dividend

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Unformatted text preview: d by the research of John Lintner, who found that corpo- 5. Theoretically, in an efficient market, owner considerations are automatically handled by the pricing mechanism. The logic is as follows. A firm that pays a dividend that is smaller than required by a large number of owners will experience a decline in price because the dissatisfied shareholders will sell their shares. The resulting drop in share price will (as explained in Chapter 7) raise the expected return to investors, which will cause the firm’s WMCC to rise. As a result—all else being equal—the firm’s optimal capital budget will become smaller, and the demand for retained earnings will fall. This decrease should allow the firm to satisfy shareholders by paying the larger dividends that they demand. In spite of this logic, it is helpful to understand some of the important considerations underlying owner behavior. 6. It is illegal to consider the owners’ tax status in making dividend policy decisions, although it is difficult for the IRS to enforce this law. Rather, the IRS will look for high retained earnings and high liquidity. Firms in this situation are penalized through the excess earnings accumulation tax. It is quite difficult, if not impossible, to determine the extent to which the tax status of a firm’s owners affects dividend policy decisions. CHAPTER 13 FOCUS ON ETHICS 569 In Practice Were Ford Managers Hoarding Cash? When managers don’t pay dividends or pay only minimal dividends, they open themselves up to the charge that they are hoarding cash unnecessarily. Shareholders may believe this is unethical if they are convinced that managers are simply playing it too safe in order to protect their jobs and (by reducing the number of new stock or bond issues) to keep from having to answer to external funding sources. Some of these companies sell products in slow-growth markets and cannot point to future asset-funding requirements to justify their cash buildup. “Empirebuilding” behavior, whether investing in negative-NPV projects or hoarding cash, reminds us once again that shareholder wealth maximization has to be ethically constrained. But this lesson can be taken too far. Automakers such as Hint The risk–return concept also applies to the firm’s dividend policy. A firm that lets its dividends fluctuate from period to period will be viewed as risky, and investors will require a higher rate of return, which will increase the firm’s cost of capital. Dividend Policy Chrysler and Ford have come under fire for investing too much in cash and short-term securities. Investor Kirk Kerkorian successfully forced Chrysler to make a one-time $1 billion payout to stockholders in 1996. Ford held the largest cash and security balances in corporate America: In 1999, when Jacques Nasser became CEO, its cash and securities totaled $14 billion more than its entire debt. Nasser invested chunks of that cash when acquiring Volvo and Land Rover, and he also initiated a combined $5.7 billion cash dividend and share repurchase. But maybe he went too far—or maybe his timing was bad. (Did you hear about the $...
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