Question

vi. Discuss the relevant theory (Information content (signalling) hypothesis,Free cash flow hypothesis ,Clientele effect )with the findings in (iv) and (v).

(iv)

SFC company

Final dividend change  14.00-13.00=1.00

Three days excess return=7.14%-0.84%=6.3%

Two days excess return=10.13%-0.40%=9.73%

(v)

SNL company

Final dividend change=3-4.25=-1.25

Three days return excess: -1.21%+1.21%=0

Two days return excess: -1.21%-0=-1.21%

OGC company

final dividend=1-2=-1

three days return excess= -6.02% -2.39% = -8.41%

two days return excess= - -7.47% - 0.19% = -7.66%

Answer 1

In given case

There is a data about of two companies where in it talks about Interim Dividend (Final Dividend) and return difference due to dividend declaration. Most common pattern followed by companies is to distribute an interim dividend at the end of the first half year, and then the final dividend at the financial year-end. Whenever a dividend is announced by the company’s board of directors after the board meeting, the date on which the dividend is to be distributed is announced. This is often announced weeks in advance from the date of dividend distribution.

Now let's discuss about Information content (signaling) hypothesis with reference to these company data. Dividend signaling is a theory that suggests that when a company announcement of an increase in dividend payouts is an indication of positive future prospects. Dividend signaling theory has been treated skeptically by analysts and investors; there has been regular testing of the theory. On the whole, studies indicate that dividend signaling does occur. Increases in a company's dividend payout generally forecast positive future performance of the company's stock while, conversely, decreases in dividend payouts tend to accurately portend negative future performance by the company. The dividend signaling theory suggests that companies paying the highest level of dividends are, or should be, more profitable than otherwise identical companies paying smaller dividends. This concept indicates that the signaling theory can be disputed if an investor examines how extensively current dividends act as predictors of future earnings.

So here you can see that Final dividend of SFC Company is positive (+1) while Final dividend of SNL Company is (-1.25) same with OGC Company dividend (-1) which means SFC company is doing well and they have better future. In line with the dividend you will find that SFC company has given better return and access written has been 6.3 % in case of 3 days excess return and 9.73% in case of two days access return.

Now let's talk about free cash flow hypothesis theory with regards to these two companies data,

The hypothesis that higher debt levels discipline managers by forcing them to make fixed debt service payments and by reducing the company’s free cash flow. In another word

The theory is that a company that generates a lot of free cash will be less disciplined with its spending than a company that has legal obligations (debt) on which cash must be spent.

An imperfect comparison would be someone who has a mortgage versus someone who lives rent-free in his parents’ basement. In an ideal world, the person with the mortgage would be more careful with his money because he has a legal obligation to pay his mortgage every month.

As with many theories of this kind, it is problematic. It doesn’t tell us much about the appropriate level of indebtedness, nor does it take into account the optionality that liquidity provides. Debt can be useful, or it can be an albatross.

So in given case where SNL has negative final dividend value than SFC and OGC it means these two companies SNL & OGC has more debt than SFC and it will reduce the cash Flow for SFC & OGC.

Now with regards to Clientele effects theory it is like a theory stating that a company's stock price increases or decreases according to changes in the company's policies. For example, if a company raises its dividend, investors are more likely to buy that company's stock, which would increase the price. Likewise, if a company has an excessive amount of debt, investors are unlikely to want to buy the stock and the price will decrease.

The clientele effect can be effectively demonstrated by referring once again to the tradeoff graph. If a firm fits the dividend profile implied by point A (low dividend, high expected capital gain) it would tend to attract investors less interested in current dividend income and more interested in capital appreciation of the firm's stock. Conversely, if a firm fits the dividend profile suggested by point B (high dividend, low expected capital gain), it would tend to attract a clientele more desirous of high, steady, current income.

Clearly, once a firm establishes its payout pattern and attacks a given clientele, a shift in dividend policy would be ill-advised. While such a shift could occur, it would be tremendously disruptive to shareholders' portfolios. First, it would alter the manner in which total return would be received. Some retired shareholders who had elected high payout firms would be faced with lower current income and the prospect of not being around in the distant future ("not being around"—I wonder what that means?) to enjoy the expected capital gain return that a low payout profile entails. Younger investors who had elected to go with low payout firms that switched to a high payout would now be faced with a higher tax burden and the prospect of not having the expected long-term capital gain. While investors could subsequently switch to firms that offered the payout profile they desired, such changes would entail brokerage fees and general hassle costs. It's quite probable that a firm that caused its clientele to weather these disruptions might be rewarded with a lower stock price for their efforts. Typically, we see that once a firm establishes its payout pattern they try to stick with it because they have attracted a given stockholder base.

So same even in this case a company SFC whose is giving more dividend attracts the investors to buy the stock which will increase the price in market and better capital appreciation for investors also client will get better return however same is not possible in other two companies case SNL and OGC.