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Information Asymmetry and the Problem of Informational Efficiency on Capital Markets

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Investor Expectations in Value Based Management

Abstract

The considerations regarding investors’ expectations and their purposeful creation through providing capital markets with reliable and accurate information should also include such important issues as information asymmetry and efficiency on the capital market.

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Notes

  1. 1.

    Gresham’s law is a principle which states that if at the same time there are two kinds of money, that from the legal point of view are of equal value, but one of them is perceived as better (for example, due to a higher content of ore), the “better” money will be collected (treasured) while the “worse” money will flood into circulation. In short: “Bad money drives out good”.

  2. 2.

    Karaban, B. op.cit., p. 10.

  3. 3.

    The most frequently evoked are:

    • Policy of stable dividend payments. The amount of dividend per share can increase, when a company reaches new, higher and stable (long-term) level of income. Due to inflation, many companies reviewed their dividend policy to shift to a so-called policy of stable dividend growth rate—a company establishes a target growth rate, equal approximately to the average long-term inflation rate, and it endeavors to increase the dividends by such an amount every year;

    • Policy of stable dividend payments with an extra dividend, i.e. a modified version of the stable dividend policy. A company prefers to pay low stable dividend which is increased during the period of higher income—that is an extra dividend. It has its advantages for shareholders, as low dividends with extra payments from time to time are perceived better than a reduced dividend.

    • Stable payout ratio policy—the amount of dividend changes with the changes in profit per share; in this way, shareholders can directly feel the benefits of increased income.

    • Residual (excess) dividend policy—the dividend is paid when current profits account for the capital needed to finance an investment; i.e. the dividend is paid out of the part of profits that cannot be efficiently reinvested.

    • Policy of 100 % payout is a radical view that assumes companies should dedicate all their profits to dividend payments.

    • Zero payout policy consists in keeping 100 % of profits from the current year in a company.

    Cf. Duraj (2002: 89–94).

  4. 4.

    There exist three basic preference theories: (1) Modigliani and Miller (1961) hypothesis of dividend policy’s irrelevance. The authors argue that a firm’s value depends only on its profits and operational risk, so each investor can carry out their own dividend policy by selling their shares. (2) Gordon’s and Lintner’s “bird in the hand” theory. The authors affirm that investors are more interested in current dividends than in potential capital gains. (Gordon 1963; Lintner 1962); (3) tax preference theory which states that investors prefer low payouts since dividends are taxed at a higher rate than capital gains and moreover the latter are taxed only upon the sale of shares.

  5. 5.

    Companies that focus on creating value should invest in projects with a positive NPV. It does not mean they have to leave out dividends. It is possible to pay out dividends and finance new projects by an issue of shares. Such a solution is acceptable only if it is highly probable that return on the invested capital will exceed WACC and provided that the projected efficiency of means allocation will be closely monitored.

  6. 6.

    Stable dividend growth policy is applied by the best corporations in the world, such as General Electric or Carrefour.

  7. 7.

    However, if extra dividends are paid out for a longer time, shareholders may become accustomed to such payouts and they will treat them as a part of regular dividends. It might be especially dangerous since the lack of extra dividend may be perceived as a symptom that the company’s financial condition deteriorates.

  8. 8.

    Since preferences regarding dividend payouts vary between different groups of shareholders, companies may attract the type of investors who prefer this company’s particular dividend policy (clientele effect).

  9. 9.

    Shares in question may be newly issued or already in trade. Shareholders achieve benefits when reinvestment of the retained profit brings them a satisfactory rate of return, at a level comparable to alternative investment opportunities with comparable risk.

  10. 10.

    Conducted research includes: Bhattacharya S, Imperfect information dividend Policy and “the Bird In the hand” fallacy, “Bell Journal of Economics”, vol. 10/1979, p. 259–270; Miller MH, Rock K, Dividend policy under asymmetric information, “Journal of Finance”, vol. 40/1985, s. 1031–1051.

  11. 11.

    Some Polish companies that used this possibility: Szeptel, ComArch, Groclin (1999), Leta, Boryszew, Softbank, Mitex, ComArch, Skotan (2000).

  12. 12.

    It is possible to distinguish five main methods of own shares redemption: fix-price tender offer, open market repurchase program, dutch-auction tender offer, transferable put-right distributions and target stock repurchase (Szablewski 2004: 53–54).

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  1. Warsaw School of Economics Institute of Value Management, Warsaw, Poland

    Magdalena Mikołajek-Gocejna

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Mikołajek-Gocejna, M. (2014). Information Asymmetry and the Problem of Informational Efficiency on Capital Markets. In: Investor Expectations in Value Based Management. Springer, Cham. https://doi.org/10.1007/978-3-319-06847-3_6

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