Question

The president of United Semiconductor Corporation made this statement in the company’s annual report: “United’s primary goal is to increase the value of the common stockholders’ equity over time.” Later in the report, the following announcements were made: a. The company contributed $1.5 million to the symphony orchestra in San Francisco, where it is headquartered. b. The company is increasing its relative use of debt. Whereas assets were formerly financed with 35 percent debt and 65 per- cent equity, henceforth the financing mix will be 50–50. c. The company has been paying out half of its earnings as dividends and retaining the other half. Henceforth, it will pay out only 30 percent as dividends. Discuss how United’s stockholders, customers, and labor force will react to each of these actions and then explain how each action might affect United’s stock price.

Answer 1

The objective or goal of most of the commercial organization will be stakeholder wealth maximization by maximizing the share price. For this, the management may frame various strategies and implement those.

a. If they contributed huge amounts to its headquarters, it may be for renovation of the building, construction, infrastructure etc. A well equipped building and infrastructure is minimum requirement to a firm which wants to become key player.

It may not impact the value of share price in the market.

b. Any firm can mix its capital structure with debt and equity. If the cost of debt becomes low, they may give high priority to employ borrowed funds, and can invest the same in various alternatives which provide higher returns. On the other hand, if the firm offer more equity to public, then the controlling power of the firm may dilute and cost of equity will be higher than cost of debt. With this reason they may equip with more debt than earlier.

It definitely impact on the share price, in my view, the share price may slightly decline.

c. As the firm may in need of funds for expansion, diversification or for any other purpose, it definitely holds some earnings instead of paying dividends. Even the unpaid dividends also belongs to the shareholders, and it increases the share value as well as firm value in the market. The company can paid dividends now and they can raise funds in future from the shareholders or in the form of debt, but it takes some additional time as well as it occurs some cost. With this reason they may holding higher dividends as retained earnings instead of paying dividends.

It also impact on share price negatively in general.