Financial Policies and the Value of the Firm Literature review

Financial Policies and the Value of the Firm - Literature review grammatical caseThe research identified that the matter of a unwaverings dividend policy and its effect on sure sh are prices. The effects of different dividend polices on current share prices based on assumptions of perfect capital markets, rational behaviour on the part of investors and perfect certainty. The assumption of perfect markets means that all traders afford equal access to information and transaction costs such as brokerage fees and transfer tax which are normally associated with the sale and purchase of shares are non-existent. Rational behaviour indicates a preference for more instead of less and an indifference to the form that wealth takes whether it is in the form of cash payments as dividends or increases in the market value of shares. Perfect certainty on the other hand indicates that investors have no doubt in relation to the investment and fiscal policy of the firm as strong as the future lev els of profitability of all firms. Stiglitz extends the argument that the financial policy of the firm is moot to a multi- extent model. The ground for this extension is to give consideration to a wider range of financial policies to include not only a debt to equity ratio but a dividend retentiveness ratio, a debt maturity structure and possibly the holding of securities in other firms. While stressing the importance of financial policy on the value of the firm to students of finance, Stiglitz indicates that if the conditions below which the irrelevance theorems obtain are considered to be realistic it results in a reduction in the tools that they require to function effectively. Stiglitz (1974) suggested that it is possible to place the decisions that a firm makes into four groups i. the way in which investment is financed ii. the way in which revenue is distributed iii. the amount that should be invested in any particular projects and iv. the projects that should be undertaken as well as the techniques that should be employed. The first two relates to the firms financial policy while the last two relate to its investment policy. Stiglitz (1974) highlights the fact that thither is a family relationship between both types of decisions which may not be obvious. Stiglitz (1974) also indicates that two different but still closely related propositions have been confused. While they exert that a firms financial policy does not affect its value. The first asserts that the individual does not prefer one financial policy oer another and specifically to the debt to equity ratio implying therefore that there is determinate ratio for the economy as a whole while the second indicates that there might be some preference as there may be a determinate debt to equity ratio for the economy as a whole but the financial policy of a particular firm makes no difference. Stiglitz (1974) concludes that the first preposition is stronger because it indicates that the financial s tructure of the economy and therefore the firm is irrelevant while the second indicates its irrelevance in relation to the firm only. Stiglitz (1984) points out that the decisions that the firm makes are interrelated and so the decision to increase dividend and still finalise to invest would suggest that additional capital needs to be obtained. If a loan is obtained to facilitate the investment then less would be available in the following period and to either retained earnings or dividends would decrease. If instead, shares are issued to facilitate the decision to invest then the amount distributed to shareholders in the following period would decrease if retained earnings is left unchanged. Stiglitz (1974) points to shortcomings in Baumol and Malkiel (1967) and Modigliani and Miller (1958) in their discussion of on how taxation impacts the optimal financial policy of the firm. Baumol and Malkiel (1967) and Modigliani and Miller (1958) detect that debt reduces the amount of tax t hat a firm is