Question

If the focus of senior executives in corporations is to maximise shareholder wealth, discuss the following two “unresolved issues” in finance today and how they may contribute to reducing shareholder wealth:
a) What risks should firms take?   
b) Pay-out policies – the trade-off between dividends and growth.

Answer 1

Answer :-

a) The senior executives of the firms generally  look to invest in high risk projects which may generate high returns, however some of them fail to give expected returns thus eroding the shareholders wealth. The senior management wants to have good perks and bonuses which prompt them to take high risk like mergers or investing in risky projects which causes the conflict with shareholders.

The compensation that the senior management get is related to the profitability which causes the agency problem which causes the conflict between shareholders and senior management. The firms board members are the one who are acting in the best interests of shareholders of the company. The company should invest in projects that are less risky and generate good returns and improve the shareholders wealth, which will help the company in the long run.

b) The pay out policies of the firm which is a trade off between dividends and growth, is in general the rising ambiguity whether to invest the profits in upcoming projects that will increase the company to grow or distributing the profits among shareholders in the form of dividends. The shareholders mostly prefer some form of returns like dividends for the invested stocks of the company.

There are some company which has stable and constant pay out policies whereas some companies prefer residual income pay out policies. These policies are at the discretion of board members and management. The company may also let go of dividends when there are some good profitable projects which increases the stock price thus investing for growth causing a trade off between growth and dividends.