Payout Policy

Introduction

Case 26, Haveloche Corporation, gives reference to the analysis of Haveloche’s dividend policy by Haveloche’s CEO during a lecture delivered at Cokesbury College. The case starts with an analysis of the company’s background in which it is revealed that Haveloche has been in existence for more than twenty-four years now, and has since inception endeavored to carry out research in the field of electronic design. The company which mainly targets the large electronic companies that find their innovations useful has tried to remain dynamic in all endeavors. The company’s earnings are determined by the number of inventions sold, and this is mainly derived from the number and quality of researchers within the company, the usefulness of the inventions, and the cost of the patents (Stretcher 185).

Since its inception, the company has gradually evolved to claim a good repute within the electronic research field. As of 2000, the company had 102 researchers and this figure dropped down until the year 2003, when it started picking gradually. Owing to the nature of its business, the financial status of Haveloche Company fluctuates regularly especially considering that the organization depends on the usefulness of its innovations because this determines the cost and number of patents sold. Haveloche may at some point earn high returns from selling the patents of its innovations, while at other times the company gets lower returns because it faces scarcity of functional gadgets. All these aspects make the company’s cash flow highly dynamic and complicate decision making processes (Stretcher 158). This paper will give a financial analysis of the Haveloche Corporation case study and will particularly focus on the dividend policy.

Haveloche Corporation has been listed in the stock exchange market since 1994 and investors in the company receive their dividends every year in June, because the company‘s fiscal year ends at this time. Between 1994 and 2000, investors of the organization received 20% of its total earnings on an annual basis as their cash dividends. However this started to change in 2000, the dividends began to fluctuate and this was dependent on the necessity of a reinvestment. Therefore, the dividends payout fluctuated between high or low depending on the company needs for cash. According to the case study, Grange was unable to identify his dividend plan with any particular payment policy. Nevertheless, it is possible to deduce conclusions from the information he presented regarding the stock prices of the company’s and the dividends paid over the years (Stretcher 186).

Fluctuations of cash flow inevitably affects major decision-making procedures within the company, especially those that concern the returns for investors. This therefore, affects the selection of a proper and constant dividend policy that can satisfy both the needs of the company as well as those of the investors. Phil Grange, the Haveloche Corporation CEO, shows the nature of the dividends of the company through two scatter charts. In the first figure, Grange compares the dividends against stock prices for every year between 1994 and 2003. The data can be used to plot a scatter chart as shown below and the chart reflects no obvious correlation between these two variables as the dividends do not follow any particular direction in relation to the stock price. In the second figure, Grange presents the effect of change in price on the dividends and when plotted in a scatter chart, the results of this data resemble those in the first scatter graph. Just like the comparisons made for the first chart, there is no apparent correlation between the stock price and the dividends as depicted in the second chart (Stretcher 187).

In order to assess the inclination of investors for dividend against investment gains, it is imperative to consider the different theories that are linked to the study of this relationship and such theories include Tax preference, Bird-in-the-hand, and Dividend irrelevance theories. The tax preference theory makes reference to a set up with constant capital gains but fluctuating dividends. In this case fluctuating dividends have a negative effect on the investors because they yield low payouts. Nonetheless, this set up improves the growth of the business because part of the dividends are utilized as capital for the business. Thus, investors persevere through low dividend payouts as they hope for better capital gains in the long run (Brigham 553).

The Bird-in-the-hand theory stipulates that the dividends play a key role in establishing the value of a company since they are constant and specific. On the other hand, the capital returns of the organization are not constant and may fluctuate hence have an aspect of uncertainty. Investors who go for this kind of set-up prefer high payouts via their dividends. The moral in this theory is that dividends are less risky because they are certainly known and available now. On the other hand, capital gains tend to be less certain since they are expected to occur in future, and this makes investors to choose the dividends at hand over the capital gains in the bush (Brigham 554).

The dividend irrelevance theory is also referred to as the Modiglian Miller. The theory proposes that a dividend policy should not affect the capital cost or stock price in a company. Investors of a company, that employs this type of policy, use their dividends to further invest in the firm through purchasing more stocks, or selling their own stocks to other individuals. In this case therefore, the dividends do not have any influential factor in determining the value of the company. On the contrary, the returns of the organization through assessment of its assets are used solely to determine the company’s value. Critics of this theory are of the opinion that the hypothesis is surreal, because it fails to take into account the effects of tax and brokerage costs (Brigham 554).

Grange found it impossible to identify the specific dividend policy for his company because of the lack of clear-cut line among the three theories. For instance, the total annual earnings made by a company are what actually determines whether the investors receive high or low dividends. Between 1994 and 2000, Haveloche Corporation paid its investors a constant dividend of 20% and this percentage may certainly be high or low depending on the total earning for the particular fiscal period or year. Thus, this dividend policy may fall within either the bird-in-the-hand theory or the tax preference theory. This policy may be categorized under the bird-in-the-hand theory because of the fact that the dividends are constant and known and this goes to show that the investors in this case prefer a high payout in dividends rather than reinvesting in the company to facilitate high capital gains in the future. This does not rule out the possibility of the payout being low if the company’s total earnings are low and the number of investors is high. Haveloche could face such a possibility considering the fluctuating nature of its earnings. Therefore dividends are uncertain and not constant, and in this case, the capital gains remain stable at 80% to ensure that the firm does not collapse.

In 2000, Haveloche Corporation brought on board a new CEO, who brought about changes in the company’s day-to-day operations. The dividend policy of the company was also altered, whereby the new company CEO, Phil Grange, sought to ensure that the firm grew at all costs. Owing to the fluctuating nature of the earnings and capital gains of the organization, Grange chose to employ fluctuating dividends to foster the company’s development. This policy cannot fit within the requirements of the bird-at-hand and the tax theories. In both theories, the dividends and the capital gains remain constant respectively, which is not the case in Grange’s strategy. Therefore, the most probable theory that can fit in this case is the dividend irrelevance theory mainly because the dividends are paid according to the financial needs of the company. In which case, the dividends are not constant, and the payments made can be either low or high depending on the cash needs of the organization. In addition to this, the company reinvests the dividends in case there is need for more capital. Nevertheless, Haveloche’s strategy incorporates some elements that are not in line the dividend irrelevance theory, and one of these is the payment of the dividends in cash.

There is no specific correlation between the stock price and the dividends meaning that any rise in the dividends does not necessarily result in decreased or increased price of the stock. These findings depict the fluctuating nature of Haveloche Corporation, for instance, in 1994 the dividends price stood at $33, while the stock price was at $44.12. In 1995, the dividends increased to $1.33, while the stock price increased to $60.50, while in the year that followed the dividends decreased, while the stock price went up. Furthermore, in 1997 the dividends rose, but the stock price went down. This shows that the stock price reacts independently and is not determined by the dividends. Thus, an increase in the dividends can cause the stock price to respond either favorably or unfavorably (Brigham 557).

It is possible for the stock price to react independently of the changes in the dividends. However, these alterations in the dividends show the what to expect with regards to the cash flow of the company in the future. It is therefore possible for the company to increase its dividends without raising the stock price as a way of communicating the state of the firm in the stock market and if the stock prices increase after an increase in the dividends, the alterations paint better potential for higher earnings in the future and reduces chances of encountering financial problems. When the stock price reduce as a result of decreased dividends, this portends future financial risks for the company. Companies that fear implementing changes may be unable to increase the stock price relative to the dividends for purposes of preserving themselves and staying in the market (Lee et al. 298).

Recommendations

It is evident that Haveloche Corporation lacks a specific dividend policy because its CEO is unable to identify with any policy. Setting up a target dividend policy is recommended in the interest of the company, because this will improve organization and accountability. This will necessitate the company to estimate and make predictions regarding its capital needs in the next five years. Even though the firm is dynamic in nature, it has been in operation for a long time now, and this can help it to make predictions regarding its needs in the near future. Such a plan will also enable the company to establish a preferred capital structure objective in the prospect. The organization will further require an assessment of its equity needs and target payout. It is essential to make these plans flexible so as to accommodate the growth of dividend and capital gains because the company is dynamic (Brigham 556).

It is also apparent that the dividend irrelevance theory is the most applicable one for a dividend policy in Haveloche because it gives room for fluctuations in both the dividend payouts and the capital returns. It is still impossible to alter the fluctuating nature of the company because it focuses on electronic inventions and the success of such inventions depends on how useful the invention is in solving a contemporary issue. It is imperative therefore that the appropriate dividend policy incorporates such fluctuations. Offering investors high dividend payouts can have detrimental effects on the company, especially during periods of low-income turnouts. This may even cause the company to go bankrupt as it can affect the capital gains negatively. On the other hand, paying investors low dividends will be deemed unfair, especially in seasons of high-income payouts. It is thus appropriate and necessary for the company to make adjustments on the dividends according to the annual earnings of the company and its capital needs for the specific year. This fits in well with the concepts of the dividend irrelevance theory.

Haveloche Corporation has to develop a proper reinvestment plan for disbursing the dividends of the investors as this will encourage and empower the investors to buy new shares from the company’s stock through their dividends. This plan should essentially aim to avoid paying dividends in cash and encourage reinvestments through dividends. In order to attract more investors to choose this option, Haveloche can offer a discount and require no extra fees for the shares’ price for all shareholders who choose to reinvest in the company through the new stock option. Another alternative is to sell shares in the open market, rather than accepting the cash payments. Haveloche can also encourage more cooperation on this matter by offering the investors who choose this option lower brokerage costs (Brigham 579).

It is also necessary for Haveloche Corporation to consider the preferences of its existing investors before making any drastic changes. This is important given that a specific dividend policy attracts a particular group of investors. Changes in the dividend policy may not augur well with the existing investors hence eliciting a strong and negative reaction from them. Investors are important stakeholders who form a huge part of any company’s financial system and organizations must therefore consider their needs at all times.

Conclusion

Haveloche Corporation is a good case study for dividend policy as it represents the companies that embrace numerous dynamic strategies. It facilitates the comprehension of different dividend policies and how they can be applied. It also reveals how managers find it difficult to select and maintain a particular strategy or even shift to a different strategy altogether. For instance, Haveloche had to change its dividend policy because the initial strategy was hurting the capital returns for the company owing to the fact that the dividends were stable, while the net earnings fluctuated constantly. The study also helps to comprehend the relationship between dividends and stock prices, in addition to the role of changes in these variables on business enterprises. Through this study, it is possible to make predictions regarding a valuable dividend policy for an existing company. For example, one can confidently opt for one policy over the other having made an analysis of the nature of a particular company. This skill of prediction is highly important in the market. Overall, Haveloche is a dynamic company with fluctuations in close to every aspect of its administration and as such the most appropriate dividend policy for the firm is the dividend irrelevance policy because it gives room for the company to change the amount of payments according to the constant fluctuations that it faces.

Works Cited

Dividends and Dividend Policy: Epub Edition. John Wiley & Sons Inc, 2009. Print.

Brigham, Eugene F, and Michael C. Ehrhardt. Financial Management: Theory and Practice. Mason, Ohio: South-Western, 2013. Print.

Dividends and Dividend Policy: Epub Edition. John Wiley & Sons Inc, 2009. Print.

Lee, Cheng F, Alice C. Lee, and John C. Lee. Handbook of Quantitative Finance and Risk Management. New York: Springer, 2010. Print.

Stretcher, Robert. Cases in Financial Management. New York: Prentice Hall. 2005. Print.