This paper presents a very realistic objective of the firm, which is consistent with organizational behavior. It is being proposed that: The firm sets as its objective, the control of the optimum amount of financial capital at the minimum cost to the firm. As evidenced by the large portfolios of marketable equity securities held by non-financial firms, the firm hoards financial capital in order to ensure future availability. There is a holding or storage cost; that is, in pursuing this objective, the firm incurs (pays) a premium to ensure control over an attained level of financial capital. This study maintains that this cost is tantamount to a premium as in the case of an insurance policy. Thus, corporate earnings retention is a case of optimization under uncertainty and dividend policy is viewed as an instrument of risk management. This objective, which addresses the underinvestment problem, fills the gap on what the firm should maximize and provides an alternative to the debatable "maximization of shareholders' wealth."
As noted in the Statistical Abstract of the United States of America (1966, p. 500; 1969, p. 482; 1973, p. 475; 1992, p. 522), during the period 1960-1991, internal finance was the preponderant means of financing investment in plant assets by manufacturing corporation. At the end of 1995, the largest 25% of US non-financial corporations held $448 bn in cash and marketable securities (Harford, 1999, p. 1971). Apparently, when large well-managed portfolios of marketable securities have been acquired with hoarded financial capital, some firms, in addition to benefiting from a lower cost of capital, experience additional benefits from market appreciation, which in great part may exceed any premium penalty due to hoarding.
It is quite clear that the large corporations organized along divisional lines, where those individuals responsible for strategic (long range planning) decisions are relieved of the responsibilities for operating and tactical decisions, taken on "many of the properties of a miniature capital market" (Williamson, 1981, p. 1556). In which case, "(c)ash flows are reallocated among divisions in an attempt to secure the high yield uses" (Williamson, 1981, p. 1556). Furthermore, in a survey, it was found that, due to `an apparent concern about affecting the stock price', managers are interested in having a properly managed dividend policy. In light of that finding, the researchers concluded that management should give serious attention to dividend policy because firm value and, in turn, the wealth of shareholders can be affected by the dividend decision (Baker Veit and Powell, 2001, p. 36). |
