Shareholder’s Equity
Summary of articles
Relationship between Dividend policy and shareholder’s wealth
In this article, the author examines the relationship between dividend policy adopted in a company and the shareholder’s wealth. The objective of the firm usually is for the shareholder’s wealth to be maximized. Whatever dividend policy adopted by the firm, the decision objective ought to be maximization of shareholder’s wealth. The author begins by recognizing Modigliani and Miller’s preposition on dividend irrelevancy theory. The theory asserts that the dividends do not have any bearing on the value of the firm. According to the Modigliani preposition, the value of the firm would soon balance off and settle at equilibrium despite the presence or absence of dividends.
Shareholder’s equity would stand at a constant despite the fluctuations in the market price of the shares. This is because the fluctuations are merely temporary and have an effect in the short term only. In the long run, the market price of shares stabilizes and does not necessarily reflect presence or absence of dividends. The author uses the situation from companies in Pakistan to postulate the relationships between dividend policies and shareholder’s wealth. The author observes that Pakistan companies use past dividends and current earnings to fix their dividend pay-out. The companies also consider it appropriate to pay dividends during times of financial stability. The payment of dividends could, therefore, be a pointer to the financial position of the firm. In the same strain, a well performing company probably cascades down into good standing in terms of shareholder’s wealth. The company would essentially be of good financial standing hence the wealth of shareholders at maximum.
Impact of capital structure on the firm’s value: evidence from Bangladesh
In the second article, the author starts by asserting the position taken by Modigliani and Miller on the debt equity ratio on a firm value in their capital structure. According to Modigliani and Miller, a firm should purpose to attain an optimum debt equity balance that would ensure the company maximizes on its opportunities without overexposing itself. The author tests the influence of debt equity structure on value of shares in respect of companies listed in Dhaka Stock Exchange and Chittagong Stock Exchange of Bangladesh.
The guiding factor in making the capital structure decisions usually is the establishment of an optimum capital structure that as a matter of necessity achieves the firm’s overall objective, that is, the maximization of shareholders wealth. In the determination of the optimum capital structure, the firm usually uses the weighted average cost of capital approach. In this approach, individual costs of capitals is calculated and weighted against different proportions of capital mix to obtain the best balance. Ordinarily, the overriding objective usually is for the company to maximize the shareholder’s wealth. The wealth of the shareholder arises from the shareholder’s equity contribution in the firm. According to the author, the evidence adduced from Bangladesh appears to back the assertion relying on the pecking order theory. According to the pecking order theory, firms usually employ the use of internal sources of capital before going out to use the external sources of capital. Under this set up, companies would use the retained earnings and issuance of ordinary equity before venturing into external sources of capital like debt. In addition, the companies that complied with that approach were stable and less threatened by bankruptcy risks.
Shareholder’s equity
The concept of shareholder’s equity is broad. An all inclusive approach ought to be taken in addressing questions of shareholder’s equity. In modern accounting, several classes and modifications of equity have come up so that a strict definition cannot be obtained. Shareholder’s equity, however, connote a sense of ownership within the company. Shareholders in a company own portions of the company in the form of shares. To gain ownership of the shares, one has to purchase the shares. The shares, therefore, have a monetary value. The shares collectively constitute equity capital. Equity capital, in the company set up, constitute the owners capital in the company. Consequently, equity shareholders are technically the owners of the company. As owners of the company, they choose to invest their wealth in the company. From a stewardship point of view, the equity shareholders commit to their funds to management to take care. The primary objective of any managers often is the maximization of the wealth for which they are charged with.
Equity shareholding can also be considered in light of the duties and tasks that accrue to shareholders. The shareholders as owners become the final decision makers. As such, they make decisions concerning the company. The shareholder’s equity investment devolves on them the right to decision making. They would be held collectively liable for the decisions they make. In fact, as a general rule, shareholders earn enjoy the profits consequent of their decision making and incur the losses in the same vein. One ought then to distinguish equity shareholders from debt holders in this respect. In the case of the former, the profit and loss in the company is enjoyed or incurred by the holders, in the latter; their reward comes in the form of interest. The interest is fixed. As such, debt holders do not have the decision making rights. The risk involved in debt is also lower considered that the debt is paid back and the interest on it fixed despite the financial performance of the company.
Equity shareholding has played a pivotal role in both dividend policy formulation and capital structure determination. Shareholders enjoy a primitive form of remuneration in the form of dividends. The dividends would be declared only in instances when the company has earned profits. However, in company law, there are some instances in which the company may declare dividends despite making no profits. The gist of dividend policy resides in the objective to boost the market position of the firm in terms of the share prices hence the shareholder’s equity. Despite Modigliani and Miller’s dividend irrelevancy theory, it has been proven that markets generally react to shares in appreciation of dividend policy.
Therefore, the dividend policy of a firm has a bearing on the value of the equity share. On the other hand, capital structure denotes the balance between equity and debt capital in financing the company. According to the pecking order theory, firms ought to exhaustively use internal sources of capital such as retained earnings and issuance of ordinary capital before venturing into external sources of capital. Despite the fact that debt capital is cheap and less prone to risk, the bankruptcy risk levels increase significantly making the employment of debt capital a secondary alternative to use of equity capital.
Application of shareholder’s equity to health care financing
Health care financing relates to funding systems in healthcare. Ordinarily, companies invest in diverse portfolios in the market. One such portfolio could be an investment in healthcare provisions. In such a set up, the shareholder’s equity would be tailored towards achieving healthcare services. However, from a business perspective, one would still expect the firm to profit from the provision of healthcare services. The profit motive is not necessarily dispensed with even in the event of healthcare services.
However, the approach taken deviates briefly from normal operations that characterise typical businesses. In healthcare funding, profit maximization approach in decision making may not bear much fruit. Shareholders retain their equity in the firm but do not necessarily execute all their decision making powers. Some powers remain on the medical management to make based on what is beneficial for the fraternity and the long term interest of society. In addition, in healthcare financing, a lot of weight is placed on the final consumer of the products. The consumer in this case is the patient in the hospital bed, or the surgical patients needing surgery or the casualties in an accident.
Shareholder’s equity has cascading effects on the dividend policies as well as the capital structure of the firm. Healthcare financing is no exception to that norm. Managers would declare dividends depending on the overall performance of the company. In that strain, healthcare organizations need to maximize on their potentials so as to earn as much profit as possible. However, given the humanistic approach healthcare services assume, the typical obsession with profits witnessed in normal companies does not exist. It should be noted that healthcare being a social service, firms dealing in the provision of healthcare are not necessarily speaking strictly profit oriented.
References
Baker, J. J., & Baker, R. W. (2009). Health Care Finance. New York: Jones & Bartlett Publishers.
Banks, E. (2006). Finance: The Basics. New York: Taylor & Francis.
Chowdhury, A., & Chowdhury, S. P. (2010). Impact of Capital Structure on Firm's Value: Evidence from Bangladesh. Business and Economic Horizons, 3(3). Retrieved from http://www.businessjournalz.org/articlepdf/EFR_2202april22m29v1.pdf
Groppelli, A. A., & Nikbakht, E. (2006). Finance. New York: Barron's Educational Series.
Gul, S., Sajid, M., & Razzaq, N. (2012). The Relationship between Dividend Policy and Shareholder's Wealth. Economics and Finance Review, 2(2), 55-59. Retrieved from http://www.businessjournalz.org/articlepdf/EFR_2202april22m29v1.pdf
