TAXATION AND CLIENTELE EFFECT OF DIVIDENDS

On the occasion when dividends and capital gains are differentially taxed, it becomes logical that equity investors would set themselves into heterogeneous classes, or ‘‘clientele,’’ by their effective tax brackets. In some countries, dividends are more tremendously taxed than capital gains, so investors with high tax debt tend to favour firms with lower dividend payout ratios, ceteris paribus. Investors subject to lower effective tax rates should behave in a complementary fashion and hence favour firms with higher payout ratios.

Differential taxation of dividends might impact equilibrium asset prices. Rational investors should be attracted only by after-tax returns, so it seems possible that firms with higher dividend payout ratios might have higher pre-tax expected returns, ceteris paribus (unless firms can arrange themselves in perfect correspondence with clientele. Whether or not it has an impact on asset pricing, dividend taxation represents a mystery with regard to the financial policy of corporations: if firms able to distribute cash through lower-taxed methods, for instance share repurchase, why are dividends ever paid?

Dividend clientele have been studied for couple decades. They are part of the asset pricing debate since heterogeneous clientele are implied by a dependence of expected returns on dividend taxes. The opposite is not true; clientele could still exist even with no asset pricing effect of taxation. For an investor to hold a stock over the ex-dividend date, the ex-dividend price decline must be less than the dividend by an amount that depends on the relative difference between the marginal effective dividend and capital gains tax rates. In purpose to try the presence of the clientele effect, two variables were hypothesized which should affect stockholder's desire to invest in a company. The first was the firm's dividend yield. The lower a firm's dividend yield the smaller the percentage of his total return that a stockholder expects to receive in the form of dividends and the larger the percentage he expects to receive in the form of capital gains. Therefore, investors who hold stocks which have high dividend yields should be in low tax brackets relative to stockholders who hold stocks with low dividend yields.

The second variable that we hypothesized might affect the ex-dividend behaviour of common stocks was the payout ratio. Firms that paid out a high percentage of their earnings as dividends would, all other things being equal, grow (both in terms of market price and earn-ings) at a slower rate than firms which retained a larger percentage of earnings. Thus, the high payout firm should attract stockholders in relatively lower tax brackets than the low payout firms.

WEIGHTED AVEERAGE COST OF CAPITAL AND GEARING

It is rare to find a company relying solely on one source of funds. The balance sheets of even modest-sized businesses show that companies raise investment funds through a variety of channels. Furthermore, they pay different rates on the various components of their capital structures. The resulting overall cost of capital, is usually referred to as the weighted average cost of capital (WACC). As the term suggests, the WACC is simply the sum of the costs of the individual components of capital where each component is weighted in accordance with its relative importance in the total capital structure.

The WACC is important for two closely inter-linked reasons, Firstly The analysis of the cost of the individual components of capital showed that the cost of capital is pivotal to the relationship between expected future cash flows accruing to a particular capital asset and the market value of the asset. We saw that the market value of a capital asset is the discounted value of the expected future cash flows, with the cost of capital acting as the discount factor. Similarly, a company’s WACC is critical to measuring the relationship between the expected future cash flows and the total market value of the company. And secondly The analysis of the WACC allows us to confront the question of whether changes in the level of gearing can affect the overall cost of capital that a company pays and, by implication, the total market value of the company’s assets. In other words, does there exist an optimal capital structure, where the cost of capital is minimized and the value of the company maximized?

Gearing occurs when a company is financed partly through fixed return finance for instance loans, loan stock & debentures and  finance  For instance  loans, loan stock & debentures) and  partly through equity. Loan financing is a cheap source of finance, It happened because there is low risk to lenders and also because it is tax deductible. According to the traditional view this will be resulted in a lowering of the WACC. Gearing - Modigliani & Miller’s View In 1958 a theory was published by Franco Modigliani and Merton Miller which said that it did not matter whether a company that it did not matter whether a company had a level of gearing of 2% debt or 90% debt, the WACC would remain unaltered.

There are 3 theories about the relationship between WACC and gearing, The first one is conventional theory. In this theory, when there is only equity, the WACC starts at the cost of equity. As the more expensive equity finance is replaced by cheaper debt finance, the WACC decreases. However, as gearing increases further, both debt holders and equity shareholders will perceive more risk, and their required returns both increase. Inevitably, WACC must increase at some point. This theory predicts that there is an optimum gearing ratio at which WACC is minimized. The second one is Modigliani and Miller (M&M) without tax, in this theory M&M were able to demonstrate that as gearing increases, the increase in the cost of equity precisely offsets the effect of more cheap debt so that the WACC remains constant. The final one is Modigliani and Miller (M&M) with tax, in this theory, Debt, because of tax relief on interest, becomes unassailably cheap as a source of finance. It becomes so cheap that even though the cost of equity increases, the balance of the effects is to keep reducing the WACC.

Whichever theory you believe, whether there is or isn’t tax, provided the gearing ratio does not change the WACC will not change. Therefore, if a new project consisting of more business activities of the same type is to be funded so as to maintain the present gearing ratio, the current WACC is the appropriate discount rate to use. In the special case of M&M without tax, you can do anything you like with the gearing ratio as the WACC will remain constant and will be equal to the ungeared cost of equity. The condition that gearing is constant does not have to mean that upon every issue of capital both debt and equity also have to be issued. That would be very expensive in terms of transaction costs. What it means is that over the long term the gearing ratio will not change. That would certainly be the company’s ambition if it believed it was already at the optimum gearing ratio and minimum WACC. Therefore, this year, it might issue equity, the next debt and so on, so that the gearing and WACC hover around a constant position.

HOW NORTHERN ROCK’S BUSINESS MODEL AFFECTS THEIR PERFORMANCE DURING FINANCIAL CRISIS

In 1990s the business model for banks has reformed to an equity culture with the main focus on faster share price growth and earnings expansion. The strategy has changed to activity based on trading income and fees through securitization which let the banks to grow earnings while economizing on capital at the same period. Northern Rock largely pursued the recently popular “originate and distribute” business model right before their collapse. They commenced mortgage loans, securitized and sold most of them to other parties and in return they are collecting fees for these services. Hazardous business model had been operated by Northern Rock and supervisory authority did not sufficiently monitor their business model, and it was proved by their business model where short-term funding could be rolled-over on normal terms applicable in that bank for several years. A tremendous disruption of financial intermediation leads to colossal economic and social costs, hence to preserve financial stability is one of the priorities of authority and central banks throughout the world.

A change in strategy from a traditional bank’s policy of possessing the loans that it comes from its balance sheet until maturity was involved in securitization. In addition, asset-backed securities that were formed by packaging loans and other assets were sold by bank to investors in securitization. Because of most investors prefer assets with short maturities, off balance sheet has been created by the commercial bank to be vehicles that shorten the maturity of long term structure products. To invest in long-term assets and borrowing using short-term paper discloses them to funding liquidity risk were the strategy of the off-balance sheet vehicles because the commercial paper market might suddenly become dwindle.

Northern Rock put securitization as the central part of bank’s overall business strategy and their reliance on short-term market funding was the central feature of their business model . Northern Rock’s business model left them vulnerable to the eagerness of the market to continue to buy its securitized bonds and to lend to it. When the market began to distrust the quality of the mortgages that serve as collateral for these securities, first in the United States, Northern Rock’s source of funding, and its cash flow, dried up. Securitization has been viewed as an efficient form of financial innovation since long time ago, it increases economic efficiency, with positive impact for borrower and lender, and spreads risk, by that reducing banking fragility, only now are policymakers waking up the problems caused by lack of transparency and complexity in securitization. On Observers point of view regulation should be made to prevent banks like Northern Rock, which acquires liquid liabilities and illiquid assets, from undergoing such a risky business model; shortly, regulators should demand such banks to maintain a proportion of their investments in liquid assets, where that portion is a function of their funding strategy.

The innate frailty of Northern Rock’s balance sheet could not combat the market’s deviation from lending to or purchasing from mortgage lenders after the revelation of difficulties in the American sub-prime mortgage market. The role taken by securitized notes has received substantial analysis in the Northern Rock episode. It has become the received knowledge that such securitized notes made Northern Rock’s business model abnormal, its balance sheet less traditional, and there is the way that securitization was responsible somehow in Northern Rock’s downfall

THE FORM OF CROWDFUNDING

The consumer’s role has recently expanded to include investment support. This phenomenon, called crowd-funding, it is a collective effort by people who network and pool their money together, usually via the internet, in order to invest in and support efforts initiated by other people or organizations. The idea that some people may decide to pay for producing and promoting a product (instead of buying it), and bear the risk associated with that decision, represents a further step in the evolution of consumers’ roles, that involves a mix of entrepreneurship and social network participation.

There are two forms within crowd funding. First form, consumers were invited by entrepreneur to pre-order the product for example many projects on Kickstarter are funded in that form. To be able to launch production, the amount collected by the entrepreneur through pre-ordering must cover the required amount of capital. Because any remaining consumers will pay a different price when the product is on the market, pre-ordering enables the entrepreneur to price discriminate between the first group (those who pre-order and thus constitute the funding “crowd”) and the second group (the other regular consumers who wait until the product is available to purchase it). This form of crowdfunding constitutes a special form of behavior-based price discrimination, because consumers self-select into one group according to their personal preferences. In the second form of crowdfunding, the entrepreneur solicits individuals to provide money in exchange for a share of the profits or even to purchase equity securities issued by the firm (e.g., cartoon projects on the platform Sandawe rely on this form). These investors may or may not decide to become customers at a later stage. It is called profit sharing crowdfunding. In both forms of crowdfunding, the participants to the crowdfunding mechanism, whom we refer to as “crowdfunders”, enjoy some additional utility over other,  regular” consumers. Crowdfunding is most often associated with community-based experiences that generate “community benefits” for participants.

Through price discrimination, the entrepreneur can extract some of the community benefits from crowdfunders through this discriminatory price setting. Conversely, when the amount of capital needed is large, the entrepreneur is forced to distort the optimal pricing scheme to attract more people to pre-order; otherwise, he or she may not be able to raise enough money to begin with. The larger this distortion, the smaller are the gains from opting for pre-ordering. Crowdfunding through profit sharing, the benefits will be higher higher when capital requirements are large. For larger capital requirements, entrepreneurs prefer to have the up-front investment financed through investor contributions rather than through pre-sales of the product, even if fewer individuals end up buying the product.

When crowdfunding comes from pre-ordering, community benefits stem directly from the consumption experience. For example, in Verity Price's case, crowdfunders could vote on which songs were on the album and what artwork was used; in the case of Blender Foundation, crowdfunders enjoyed being part of user groups that made open source of the software possible. These community benefits assessed by assuming that crowdfunders perceive an increase in the product quality, Community benefits therefore increase the crowdfunders' utility in proportion to their taste parameter: a consumer who values the product will also value the enhanced consumption experience that crowdfunding provides.

In contrast, when crowdfunding comes from profit sharing, community benefits are related more to investment than to consumption. Participating in crowdfunding is through investment, and the crowd can support the firm without necessarily becoming a consumer. Crowdfunders enjoy an increase in utility because they value the feeling of belonging to a group of “special” or “privileged” individuals (individuals who contributed to the very existence of the product). As mentioned previously, Seedmatch organizes meetings between crowdfunders and founders of the funded companies. Here, community benefits do not depend on the identity of the consumers, all crowdfunders enjoy the same increase in utility, regardless of their taste parameter.

HOW’S THE MERGER OF BRITISH AIRWAYS AND IBERIA FINALLY ABLE TO CAPTURE SIGNIFICANT PROFIT IN 2013

British Airways and Spain's Iberia announced in November 2009 a preliminary agreement for a $7 billion merger to create the world's third-largest airline by revenue. The deal that was close by the end of 2010 ends the British flag carrier's long pursuit of Iberia to create an enlarged group, to able to cope with the industry's largest decline in decades. The deal will create a new holding company, which will own the two airlines. In 2011 International Airlines Group (IAG) was formed by the merger of British Airways and Iberia. The merge resulted in two airlines joining forces in all-stock transaction.

 

Since the merger Iberia kept pushing the IAG deep into the red zone. It occurred because the Spanish national carrier has battled against recession, high unemployment and competition from low-cost rivals. In May 2013 IAG unveiled a €670m pre-tax loss for the first three months of the year. Mostly it is due to €311m of exceptional charges, predominantly related to the restructuring of Iberia, which is laying off more than 3,000 staff. Iberia made operating losses of more than €200m during the period as the carrier continued to struggle against Spain’s deep recession, which has pushed unemployment to a record 27%. By contrast, BA made losses of £58m.

The huge loss margin between British Airways and Iberia showed how unbalance is the companies inside IAG. Unlike Air France and KLM which both of them are competitive in full service carriers, Iberia as a national airline is not competitive enough in the market. They are even not able to compete with Ryanair, Easyjet, and other Spanish low cost airlines. IAG have to come with bright plan to overcome this issue and some significant actions need to be done by IAG if they aim to return to the profit.

After suffering huge loss IAG executed a restructuring plan on Iberia. Iberia, whose performance has dragged on the group since the merger with BA in 2011, had made progress narrowing its loss by £153million to £137million. This has been achieved through cost-cuts, including thousands of job losses, and reducing unprofitable Latin American routes to destinations such Havana, Cuba. Iberia's restructuring saw 2,500 staff leave the airline under a voluntary redundancy program, while salaries were reduced by between 11% and 18%. As a result, Iberia's employee costs were down 14.3% for the year. The pay and productivity agreements between Iberia and its pilot and cabin crew unions that they were made are also the key to reducing the airline's costs further and providing the foundation for profitable growth. As a result Cost-cutting and productivity improvements at Iberia had contributed to a healthy share price for IAG.

IAG’s new low cost operation Vueling, which it bought last year and competes with Ryanair and EasyJet, had also performed well in Europe. Acquiring low cost Spanish carrier Vueling is a brilliant move that was done by IAG in 2013. Vueling never suffered a loss in the last 5 years and their revenue always gone up tremendously since 2008. It was brilliant acquisition since Vueling is main threat for Iberia before the company was acquired by IAG in 2013.

British Airways profit climbed up to £651million from £274million boosted by a growth in “premium” passengers as businessmen took more flights to the US and Asia as the economy recovered. In addition, more take-off and landing slots at Heathrow as a result of its BMI takeover in 2012 also helped as did more flights on bigger planes such as the A380 Superjumbo. As a result AIG turned around 2012’s €774 million (£635 million) loss to post a pre-tax profit of €227 million per 31 December 2013.

However, they will still face some issues in the future. Uncontrollable fuel costs remain a headache, whilst a reinvigorated Ryanair could eventually bring pressure to bear on the group’s new Vueling business. Moreover, uncertain economic condition is also the biggest threat for the sustainability of IAG.