Free Cash Flow, Issuance Costs, and Macroeconomics
Risk
Qiaozhi Hu
Questrom School of Business
Boston University
June 30, 2015
I thank Dirk Hackbarth, Andrew Lyaso and MF930 participants at Boston University for helpful comments.
Send correspondence to Qiaozhi Hu, Boston University Questrom School of Business, 595 Commonwealth Ave,
Boston, MA 02215, USA; telephone: (732)809-1105. E-mail: qiaozhih@bu.edu.
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Free Cash Flow, Issuance Costs, and Macroeconomics Risk
Abstract
This research proposal develops a dynamic framework analyzing the impact of macroeconomic conditions on dividend policy, equity issuance policy, stock prices and agency costs of free cash ow. I begin by observing that both equity issuance and agency costs both depend on the aggregate state of economy. However, the existing literature is silent on the stock price dynamics and agency costs of free cash ow in the presence of macroeconomics risk, issuance and agency costs. I then describe the expected results: (1) Characterizing the rm 's optimal equity issuance and dividend pay out policies in dierent regimes; (2) Study on the stock price and asymmetric volatility under the optimal cash management policies in the presence of macroeconomic risk; (3) The model would probably predict free cash ow problem is more severe in expansion regime than that in contraction regime. A literature review is added to talk about the prior research in the related areas. I also analyze the rst-best benchmark case where
The discussion here must present the repercussions of a share repurchase decision on the share price, as well as on the dividend question. Signaling and clientele considerations must also be considered.
considered to be linked to stock prices. Dilon and Owers (1997) argues that, if the
Financial stocks are the shares issued by financial industries. With the development of global economics, the volatility of global stocks market reflects the economic situation across a number of countries. As a result, each nation’s fluctuation of stocks plays a significant role in its own economy. Furthermore, the financial stocks that act as an important sector of the whole stock market are caused fluctuating by a large number of factors. Without exception, there is a great number of reasons for the volatility of Australian financial stocks, which cause the whole financial share market fluctuating unsteadily in Australia as well. The purpose of this report is to discover the most influential cause of financial stocks volatility in Australia. Moreover, This report will analyse three main factors: a combination of three financial instruments, legal framework and inancial industry fundamentals, which influence the volatility of Australian financial stocks.
When dividends are received, the amount is credited to the dividend revenue as they are regarded as a reduction in the investment made. Here the percentage of stocks purchased fall between 20 and 50 percent. For companies owning more than 50% of the total share, the consolidated financial statements are used. They include consolidated balance sheets, income statements, and cash flow statements. The equity method is used to account for the investment in the subsidiaries (Levy,
While conducting the analysis of EMI group’s dividend policy, one factor that stood out to us was the clientele effect. The clientele effect shows us who holds most of our outstanding shares. High tax-bracket individuals would prefer zero-to-low dividend payout to save on taxes. Low tax-bracket individuals would prefer a low-to-medium dividend payout, which gives them additional income while helping them save on taxes. An investing corporation would prefer a higher dividend payout because if they own a significant amount of shares, say 1 million, the income stream from that dividend would provide the company with more monetary resources while benefitting from tax exemptions. So before setting a dividend policy for EMI group, we must first
Efficient market hypothesis proposed by Fama (1965) suggested that all relevant information is immediately incorporated into current stock prices. Moreover, stock prices change when new information come. Since new information is unpredictable, EMH implies that stock prices follow a random walk.
Dividend policy is at the theory core of corporate finance. It is one of the most debated topics in the finance literature and still keeps its prominent place. Many researchers have devised theories and provided empirical evidence regarding the determinants of a firm’s dividend policy. The dividend policy issue, however, is yet unresolved. Clear guidelines for an “optimal payout policy” have not yet emerged despite the voluminous literature. Yet we still do not have an acceptable explanation for the observed dividend behavior of companies. We are yet to understand completely the factors that drive dividend decision and the manner in which these factors interact. This is known as the dividend puzzle in the finance literature. Several hypotheses have been put forward to shed some light on this puzzle but in vain.
〖X'〗_(i,t) is a vector of explanatory variables and includes all the relevant factors identified in section 3.2. Table 2 in the appendix provides a summary of these variables, their measures, empirical evidence and expected sign. 〖PV〗_it is the payout variable analysed as only dividends, only repurchases, both or total payout. The paper
The role of risk-free rate in the financial analysis is of vital importance because it allows the cost of both equity and total capital to be assessed. For a particular security to be characterized as risk-free, the actual returns should always be equal to the expected one. The aforementioned fact presupposes the satisfaction of two criteria: The first indicates that the stock is free of default risk and the second declares that there can be no reinvestment risk (Damodaran 1998). However, no security is truly risk-free due to the exposure of its returns to inflation risk. Even, Treasury inflation-protected securities (TIPS) , which are indexed to inflation, are not risk-free (Shen1995).
1 EfficientMarket Hypothesis (EMH) . . . . . . . . . . . . . . 13-3
In practice, dividend policy will be affected by taxes as tax rates for different categories of investors will differ. Also, a firm’s dividend policy is perceived by the financial markets to be a signaling mechanism. A cut back in dividends may signify that the firm perceives tough
The dividend policy has grown over the years. This may be so that the company projects itself as a less risky share and thus also gaining investors faith. The investors buy its shares and thus increase its demand. This helps to gives positive signals to the investors signalling that the company is stable and can generate earnings steadily. This hypothesis is gains standing from the dividend hypothesis theory.
Since investors do not need dividends to convert share value to cash, dividend policy will have no impact on the value of the firm, this is because investors can create cash by using homemade dividends. In addition, a persuasive argument claimed by Miller and Modigliani (1961) that dividend policy does not matter, in other words, dividend policy is irrelevant to the shareholder’s wealth. However, dividend irrelevance argument must under certain assumptions: 1) there exist a perfect capital market which means no taxes or transactional cost, free and costless access to the market information; 2) investors agree on the expected cash flow from a given investment; 3) no agency cost; 4) financing decision and investment decision are independent; 5) investors can borrow and lend at the risk free rate.
The first objection is related to the fact that this is a totally new approach concerning dividend policy, and nobody can predict what is going to happen. We consider that this may have positive effects on share prices, especially taking in consideration that it will stabilise the market price of the company.
As known, ensuring price stability was the ultimate aim of the monetary policy by targeting an inflation rate or interest rate. Before the global financial crisis, most central banks took an expansionary approach to asset price and credit booms. As a result, monetary policy was to react to changes in asset prices and credit aggregates only to the extent that they affected inflation (Bernanke and Gertler, 2000). After the crisis, policy makers recognized the dangers associated with financial imbalances so that central banks tending to follow the flexibility. In many financial markets, considering about financial imbalances like foreign-exchange rate, interest rate, unemployment rate and fast credit growth becomes a more significant role on monetary policy. Meanwhile, there is no doubt that monetary policy has a direct effect on financial markets like stock market, bond market, mortgage market and so on. The aim of this article is to focus on the relationship between monetary policy and stock market movements. There is evidence that the stock returns is affected by the money supply rate. The link between the two parts is particular interest and the stock prices are sensitive to economic conditions. Therefore, the stock prices’ trend is able to become a reflect of the monetary policy’s influences on stock market. In total, one of the ways that monetary policy uses to stabilize the financial market is to adjust interest rate, which affects firm’s equity and the stock liquidity.