Financialization: Stock Market and Share Buy-back Strategy Essay

1419 Words Dec 25th, 2008 6 Pages
What do you understand by the term financialization? What factors are driving US firms to distribute more of their cash to shareholders?

The Bombardment of the psyche of the average citizen by the financial industry in newspapers, magazines, television and the internet offering different financial services from mortgage loans to credit cards brings to mind a question raised by Ismail (2008:1) “ … if finance is everywhere does this mean that we have in some sense become financialized.”
This essay sets out to answer Ismail’s question and give a better understanding of the term financialization. Firstly various view points and opinions of the academia, economic journalist, politicians and analyst in mainstream finance will be reviewed
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Fair value accounting (FVA) reports any investment at the current market price which leads the capital employed on the balance sheet of the new entity to be inflated, a situation otherwise referred to as value absorption. This creates a scenario where the EPS of the new firm is lower than pre –acquisition state because cash earnings have not increased at the same rate as capital employed creating a situation termed value at risk. Anderson (2008) suggests that a firm can resolve this position by increasing its cash earnings by reducing expenses or buying – back its shares to reduce its outstanding share issued resulting in an increased EPS. The cyclical nature of financialization brings the firm back to its original goal of creating value for its shareholders.

Next this essay will examine factors driving US firms to distribute more of their cash to shareholders. Mitchell & Robinson (1996) suggests that the following are factors driving the distributing of more cash to shareholders by US firms this include excess liquidity, capital structure , information signaling, wealth transfers and miscellaneous motivations which will now be discussed in detail. Excess liquidity which would otherwise have been distributed as dividends are distributed through a share buy-back strategy, this is usually an option when the issue of personal tax payment is under consideration.

Capital structure of a firm consist of both debt and equity, when a firm wants to optimize its debt

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