Question: suppose a firm has a very high ROE. What should it do, pay a dividend as high as possible (signaling) or retend as much as possible (growth will increase)??
I’m pretty sure that this stuff was part of level 1: http://www.google.com/search?sourceid=navclient&ie=UTF-8&rls=GGLJ,GGLJ:2006-38,GGLJ:en&q=“bird+in+the+hand”+“signaling+theory”+“dividend+policy” http://www.business.uiuc.edu/~mdyer/chapter/chap16f03.pdf
thanks! I know, I just cannot find the page where it is. What’s the bottom line of your links. The first link only gives google answers…
I’d say it really depends on the industry and company type/size. Not all the time there is a lot of place for growth - or maybe the market conditions won’t allow it - then a higher dividend makes sense. you shouldn’t imagine that a large company would have the same growth potential as a small one
Companies can tweek ROE by loading on debt, which may be detrimental. A unusually high ROE, relative to their competitors, may signal an overload of debt/risk, better management, better productivity, etc…you have to look at why it is what it is and if it makes sense. I like FCF’s and ROIC compared to cost of capital better, or EVA. Summarizing, it depends on different things every time.
I suppose I see it differently. I don’t think we’re expected to find arguments why the purportedly high ROE is temporary or illusional. Presumably the “high ROE” means the investor’s money would grow faster in the firm than invested in some other alternative (another firm, t-bills, stripper tips, etc.) So at first glance it seems obvious the company should hang on to the funds and put them to work. Of course the investor could turn right around and buy more stock with the dividend, and (in a frictionless world) end up in more or less the same place as if the company had just kept the dividend itself. However paying dividends removes the investor’s option of deciding when to pay taxes. That’s a valuable option.
DarienHacker Wrote: ------------------------------------------------------- > Of course the investor could turn right around and > buy more stock with the dividend, and (in a > frictionless world) end up in more or less the > same place as if the company had just kept the > dividend itself. If the company keeps the dividend itself, the dividend is available for the comapny to reinvest. If the investor turns right around and goes to the secondary market (commonly refered to as “stock market”) and gives the money to another investor to buy his/her shares, the dividend is no longer available for the company to reinvest. In the first case, the investor still owns those “dividends” (which actually are not dividends but rather retained earnings) thru the ownership of the company’s shares. In the second case, the investor doesn’t have any claim to those dividends.
We recently had two thorough discussions of this question in the LI forum. The critical factor is the relationship between the cost of equity and ROE. Visit the link below and review pages 148-151 of the 2008 CFAI LII Curriculum, Volume IV. http://www.analystforum.com/phorums/read.php?11,644874,644982#msg-644982