Wall Street: Money Never Sleep

                It is a meaningful week for me because I have spent two and half hours to watch this interesting financial movie called “Wall Street: Money Never Sleep” which basically talk about greed. Today I am going to talk about some interesting topic which is related to finance. As a finance student, I assumed that everyone know about Wall Street. It is a place where investors experienced gain and loss through trading shares. Before I start, I would like to ask everyone a question. Do you think greed is a good thing? Well, I think that greed can be a kind of motivation because a person with a greedy mindset is willing to do anything to achieve what they want. However, this also means that a person will do something that is illegal to achieve their aim. Who does not have a greedy mindset? I believe all investors are greedy but everyone has different level of greediness. In this movie, Gordon Gekko was sent into the prison because he was caught doing insider trading and fraud. It is greed that causes him lost his family and spends his life in the prison.

                There is another scenario talk about Louis Zabel, the chief executive of the KZI commit suicide because he cannot accept the fact that his company collapsed. The rumors in the market caused the share price of KZI decreases rapidly and he is forced to sell his share to the FED for £2 per share.  After all, Jacob found out that the reason of KZI’s share price decrease is because that Bretton James spread rumors in the market and trying to hunt down KZI. After that, there is carnage on Wall Street which all sectors in the market are going down. The indicator of DJIA, S&P and NASDAQ turned red and the market was in a chaos condition. At the end of 2008, Bretton James is caught for doing fraud and sent into the prison.

                After watching this movie, I realized that how bad a person can be because of the greed for money. Gekko did not change the greediness of himself even after he is out from the prison instead. He just came back in a different form to cheat and betray to the people that have trusted him. He asked Jacob to tell lie to his daughter, Winnie Gekko to get back his 100million from the bank in Switzerland.

                After all, do you all still think greed is good? I believe that everyone wish to have gains instead of losses. But can everyone stop himself from being greedy because of the gain of value in the investment they made? To be honest, who hates money? In this movie, I really learned a lot about why a person will fail and cause the company collapse. For example, Bretton James greed for money was his ruin. If he did not do fraud and betray Louis, he might not end up his life in the prison. Lastly, I would recommend to people who have not watched this movie before to spend your time to watch it because it is really worth to watch. 

Dividend policy

                This week I will talked about how a company make decision between dividends or reinvest the retained earnings to some positive NPV projects. This topic is related to the previous topic that I posted last week. Every company will have their own ways to make profit. Some companies will prefer more debt than equity or vice versa. But in order to make sure that shareholders will not stop investing your company and  a company can increase its value each year, it has to give some return back to the shareholders as well. At this point, companies will come into a tough decision of either giving dividends to its shareholders or reinvest into some other positive NPV projects. Well, either way the company will also bring benefits to the shareholders in long term. Some shareholders will look at the dividend payout ratio before they invest into that company while some will look at the retained earnings of the company and what recent projects that the company plans to invest in.

                According to Modigliani& Miller (1961) theory, it says that the share prices are determined by the future earning potential not the dividends that will be paid now. Therefore, the share value is determined by investment policy and not the amount of earnings distributed. M&M also argue that he dividend decision is mainly financing and investment decision with any money that is leftover after a company invests in all positive NPV projects. Thus, the timing of dividend is not really important and investors should look at the long term of the investment instead. In my opinion, I think that dividend will not be the main concern for me to invest my money. It is because if a company chooses to reinvest the money into some NPV projects, then the share prices will increase. By that time, if investors prefer to get return back from the company, they can just sell some of their shares away. For example, Google Inc. is a big company that does not pay dividend to its shareholders. Google choose reinvest its retained earning into different type of project which has positive NPV where it may be good to shareholders because it might have a large capital gain in long term. However, by doing so, there are disadvantages to the shareholders because the risks of reinvesting money to other projects are uncertainty. Therefore, shareholders might not feel safe and confident in investing company like Google. Besides that, a company might not choose to reinvest the profit into other projects but to do share re-purchase schemes as ways of returning cash to shareholders instead. This is also a good way for the company to increase gearing without taking more debt and incurring interest cost. By doing so, it can increase the share price due to the lesser shares in the market and it can prevent someone to take over the company.  

                On the other hand, some shareholders will prefer company that pay dividend to shareholders like Apple Inc. It is because they can know whether the company is doing well or not. If a company is doing well, it could give a better dividend back to their investors and investors can use the money to invest in other positive NPV project that they prefer. Despite that, investors will have to pay taxes when they collect dividends. In company’s perspective, paying dividends will restrict the company from having lesser opportunity in investing positive NPV projects.

                As you can see, Google Inc. and Apple Inc. are large company in the world and both companies have used different method to create shareholder’s value. Thus, there is no best way of creating value for the company as well as to the shareholder’s wealth. If you are an investor, will you prefer a company that helps you reinvest your money into other positive NPV projects or give dividends? I believe most of the investors who are not willing to take high risk will prefer a company that gives dividend regularly. Please leave a comment and let me know what you think about the dividend policy for different companies.      

Debt and Equity in capital structure

                Today I will talk about debt and equity in capital structure which is taught in Week 6 lecture. In the business world, many companies are facing tough decision between debt and equity. However, both debt and equity have different ways in raising company’s capital with different costs. Many companies prefer debts more than equity. Why? One of the reasons is that the issuing and transaction costs for debt are lesser than ordinary shares. Besides that, lenders require a lower rate of return than ordinary shares because debt is less risky than ordinary shares and it has tax advantages as well. Since debts has a lot of advantage to a company, why company do not go for a 100% debt instead. Well, this is because that if a company choose to go for full debt will cause financial distress risk to the company. A higher level of debt will leads to an increase in gearing level and a decrease in the overall cost of finance that will cause the risk of the company increase at the same time. This will cause the company become financially distressed as its WACC increased and shareholders will start to demand for a higher return to compensate the higher risk of the debts. Meanwhile, too much debt is not a good thing to a company because a company still has to pay the interest even if the profits are low or high. Therefore, a company has to balance the percentage between debt and equity.  

The diagram above shows the changes of WACC between debt and equity. The WACC will falls initially because debts has tax advantage but if it go beyond the optimal debt-equity ratio, it begins to rise because of the financial distress cost.

                I have found an article which talk about European Central Bank that has recently launched its quantitative easing programme. Unfortunately, this programme failed to stimulate lending due to lack of investment from many firms. In Europe, many blue-chip companies have recently issued debt at a lower rate. However, with the cheap credit and low interest rates, many companies in Europe are still reluctant to take on more debt (Financial Times, 2015). According to Marc Zenner, the co-head of corporate advisory at JPMorgan say that a debt with low cost does not mean that its hurdle rate is low as well. It is just a slow process from QE and cheap money to get more companies to invest more. It is quite true that corporate boards seldom adjust the hurdle rate and so the impact of borrowing costs will not pass on immediately. Companies have to bear in mind that they have to repay all these debts to lenders on its maturity. So, even if the interest rate is low or cheap credit, it is not necessarily to take more debt because it may cause higher risk to the company.   

               According to Modigliani& Millar (1958) theory, it says that a company’s capital structure has no impact on the WACC. Thus, there is no optimal structure exists and a company’s value are purely depends on business risk where it can perfectly measurable by shareholders. In Modigliani & Millar(M&M) theory, it has make few assumptions like there is no taxation, no transaction costs, a perfect capital markets with perfect information available to all and there are no costs of financial distress and liquidation. In real world, this theory can be easily debate because all these assumptions are not possibly happen. Thus, M&M revised their theory to take tax into account. However, you might feel that M&M theory does not really make sense in the real world but it does help some manager to make decision on capital structure.