Question

Read Parts 1 and 2 of the article Morgan Stanley Round table on Capital Structure and Payout Policy and provide a summary of the salient points made by the panelists on the optimal capital structure and the payout policy of the firm

Answer 1

The agenda of the panel discussion:

• If there is an optimal, or value‐maximizing, capital structure for a given company?
• If there is an optimal dividend payout policy?
• Whether shareholders prefer stock repurchases rather than dividends?

Salient Points:

• The business strategy, its business plan should pave the way for the financing decision and the cash flow distribution policy.
• The capital structure and dividend policy is governed by the stage and maturity of the company.
• Growth companies require capital for growth and expansion. They have many investment opportunities where they can earn positive NPV. In such cases, the firm should
  • Preserve financial flexibility to carry out the business plan,
  • Have higher reliance on equity financing
  • Preserve capital and hence engage in limited payouts.
• Mature companies have limited positive NPV investment opportunities. They should
  • resort to more aggressive use of debt
  • Have higher payouts in terms of dividends or buybacks because they don't have that many positive NPV investment opportunities. So, it's better to return the surplus cash to the shareholders.
• The firm's excess cash must not be wasted on projects that produce growth at the expense of profitability.
• Given a choice between dividends and stock repurchases:
  • dividends appear to be a better way to distribute the surplus cash to the shareholders than open market repurchase programs.
• Between the debt‐equity decision, there is indeed an optimal level of financial flexibility
  • too little funding may lead to lost investment opportunities
  • too much of capital may lead to over investment.