The role of the boards in dividend, finance and investment policies and value creation. Good corporate governance practices.

1. Role of the Board in Determining
Dividend, Financing, and Investment
Policies
Achieving Shareholder Wealth Maximization
Module 13
Dr. Demir Yener
Corporate Governance
Senior Corporate Governance and
Development Center Finance Advisor
USAID/BPI Project
Ulaanbaatar, Mongolia

2. Purpose: To explain the role of the board in determining
dividend, investment and financing policies to achieve the
shareholder wealth maximization objective.
Outline:
 The role of the board in determining dividend, investment
and financing policies
 The impact of these decisions on value creation
 Beneficiaries of value creation
 Lessons learned
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3. Learning Objectives:
 Understand the role of the boards in determining
dividend, financing and investment policies
 How the board set targets and determines the
dividend, investment and financing policies
 Board responsibility to ensure value maximization for
the shareholders
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4. Strategic Role of the Board of Directors
Revisited
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5. Corporate Governance
Is defined as:
“the set of rules by which companies are
managed and supervised by its relevant
investor bodies such as the boards
elected by shareholders.
Practicing good corporate ensures
investors a fair rate of return.”
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6. Key Fundamentals of CG Environment
Four Values of Corporate Governance
Transparency Accountability Responsibility Fairness
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7. Ownership vs. Management
Information Needs Different Objectives
• Stock prices • Managers vs.
• Returns on stockholders
investment • Top mgmt vs.
• Issues of shares operating mgmt
and other securities • Stockholders vs.
• Dividends creditors
• Financing
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8. Financial Markets
Primary
Markets
Funds
Second
OTC
ary
markets
markets
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9. Interactions Between Financial Market Participants
Investors
Intermedi
Issuers
aries
Financial
Markets
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10. Good Governance Improves Performance
Disclosure and Transparency
• Disclosure of financial position helps set clear targets
• Holds all employees responsible and accountable for results
Audit Committee
• Checks on executive management
• Brings market perspective on risk
Management Compensation Committee
• Critical for creating the right incentives to ensure the success of strategies
Independent Directors
• Bring fresh and objective perspective to board decision making process
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11. Competitiveness and Governance
 Adopting sound corporate governance practices help
firms compete more efficiently and effectively
 Market valuation improves as corporate governance
is improved
 Focusing on wealth maximization (not profit
maximization) is an attainable goal for the firm
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12. Good Corporate Governance Focuses on
a Model in which…
Shareholders Elect the Board
The Board develops the strategy
S/Hs require that board is transparent
All relevant and material information is
disclosed to S/Hs and investors
All actions of the firm are within the law
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13. Strategic Role of the Board of Directors
OECD Principles (2004) on the strategic role of the Board
 Reviewing and guiding corporate strategy
 Approving major plans of action
 Approving risk policy
 Approving annual budgets and business plans; setting
performance objectives
 Monitoring implementation and corporate performance.
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14. Role of the Board in Finance Function
OECD Principles (2004) on the strategic role of the
Board states that:
“The board should fulfill certain key functions
including:… overseeing major capital expenditures,
acquisitions and divestitures.”
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15. The Goal of the Firm
To maximize the wealth of shareholders.
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16. Motivation to Invest
Why invest in a company?
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17. Rate of Return Expectations
• Key factors in attracting investment:
• Firms must build investor confidence that a rate of
return on invested capital can be assured to the
investors.
• There must be a conducive environment for
corporate governance to protect the rights of
shareholders
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18. Dividends in Mongolian Regulatory Framework
 Mongolian CG Code, Chapter 8 provides for dividend
policy.
 8.1 Policy on dividend policy
 Mongolian Companies Law, Chapter 6: Dividend
distribution and transfers of a company` s property
provides for:
 Article 46 Payment of dividends
 Article 47 Conditions Relative to Payment of Dividends
 Article 48 Limitations on Disposition of a Company`s
Property
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19. Board’s Role in Wealth Maximization
 The Board represents the interests of shareholders
who demand a rate of return for their investment.
 Executive management‟s goal is to create value for
stockholders.
 This goal is consistent with the wealth maximization
objective.
 Directors determine manager‟s compensation or
replace them.
 Directors monitor, control and guide the actions of the
executive management.
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20. Dividend, Financing and Investment Policies
Dividend, Investment and Financing Decisions 20
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21. Three Wealth Maximizing Decisions of the Board
 The optimal
combination of the three
Investment policy decisions ensure
value maximization.
 Executive management
is responsible for
implementing the
Financing Dividend
wealth maximizing
policies for
shareholders
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22. CORPORATE FINANCE FRAMEWORK
• Allocating • Implementing • Issue securities
FINANCING POLICY
MARKETS
INVESTMENT POLICY
2 1
capital Investment- for LT Funds
• Ensuring Finance- from investors
Dividend (Bonds and
operational Policies Stocks)
efficiencies
• Capital • Raise ST
• Creating S/H Budgeting 5 Funds from
value (Wealth (Investment banks
maximization) Decisions)
3 • Cash Budgeting 4
(Operational)
1=Raise capital in the markets, issue equity/debt
2=Allocate (Investing) funds in the firm
3=Generate operating profits
4=Pay taxes, dividends and Interest
5=Reinvest profits after tax (Retained Earnings) 22

23. ROLE OF THE BOARD IN CORPORATE FINANCE
YES
Initiate Plan GOAL:
Plan Maximize value
NO
= Goal? Minimize risk
Reexamine External
Assumptions Tangible Goals
Environment
Strategies
Long-Term
Short- Term Liquidity Financial
Investment
Structure Structure
Decisions Level of
Operating Assets
FINANCING POLICY
Corporate Capital Structure: Leverage
Risk Required
Factor Rate of Return
Trade-offs
Financing Package Plan & Analysis
Options 23

24. A STRATEGIC INVESTMENT TOOL: CAPITAL BUDGETING
INVESTMENT
DECISIONS
INVESTING Develop new Merger with or Other
In new products Acquisition of Investments
Equipment (R&D) Outside firms (environmental)
• Sales Forecast • Payback Method
• Operating Expense Selection Of
Determining • Average Rate of Return
Forecast Best Ranking
Cash-Flows • Internal Rate of Return
• Level of Working Capital Method • Net Present Value
Needed to Support Sales • Profitability Index
• Free Cash Flows
Required • Under conditions of certainty:
• Under conditions of certainty: Risk Trade-offs Rate of Present Value
No specific measure Factor
Return • Under conditions of
• Under conditions of
uncertainty:
uncertainty:
• Expected Present Value
• Standard Deviation/Expected
• Expected Utility
Return Capital Rationing
• Coefficient of Variation Selection of Constraint
Capitalization Rate
Proceed to Plan=Goal Diagram Selection of
Investment Project 24

25. Wealth Maximizing Decision
Choose the investment alternative
that offers the highest possible Net
Present Value.
NPV > 0
(For a given a required risk adjusted return)
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26. VALUATION
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27. Role of the Board for Valuation in the Mongolian
Companies Law
Article 55. Determination of the Market Value of
Property and Property Rights
• Provides for the role of the Board in the
determination of the value of property and property
rights, including the value of the shares and
securities.
• The article also provides for the treatment of market
valuation and requires votes of the majority of
members of Board of Directors, who have no conflict
of interest in the transaction to determine the value.
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28. The Value of Common Stocks
• How To Value Common Stock
• Capitalization Rates
• Stock Prices and EPS
• Cash Flows and the Value of a Business
• Price Earnings Multiple (P/E)
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29. What Is The Purpose Of Value Creation?
Focusing on value creation will:
• improve attractiveness of the company to
investors or buyers
• maximize value in joint ventures increasing the
potential value of the firm
• improve the strategic planning process
• provide a framework to reward company
managers
• And above all – maximize the wealth of
shareholders 29

30. Scenarios For Uses Of Valuation
• By companies to carry out their business:
– Strategic planning, investments, new business launches, benchmarking, capital
budgeting, performance measurement
– Mergers, acquisitions, strategic alliances, joint ventures (JVs) and divestitures
– Pre-acquisition value studies performed on either an entity or operating unit level
– Pre-acquisition purchase price allocations for financial and tax planning and
reporting
• By investment bankers as transaction advisors
– M&A, divestitures, leveraged buy-outs (LBOs)
– Initial public offerings (IPOs)
– Equity offerings
• By investors to decide whether to buy an asset:
– Private equity/LBO players, venture capital funds, hedge funds
– Asset managers, institutional investors
– Investing public 30

31. Financial Information: Major Financial Statements
(IFRS)
Balance Income Cash Flow Other
Sheet Statement Statement Disclosures
List of assets
Statement of
and liabilities
changes in
at a moment Shows Shows cash equity
in time. revenues payments
and costs and receipts
during a over a
Difference specified specified
between the period period
two is Notes
“shareholder’
s equity”
Financial Controls, Auditing and 31
Disclosure

32. Methods Of Business Valuation
Asset Based Valuation
• Adjusted Book Value
• Net Asset Value
• Replacement Value
• Liquidation Value (break-up value)
Going Concern Value
• The Earnings Multiplier Method (P/E)
• Payback Method
• Discounted Cash Flow Method (DCF): a.k.a. the “income
capitalization method
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33. Stocks & Stock Market
• Common Stock - Ownership shares in a publicly
held corporation.
• Secondary Market - market in which already issued
securities are traded by investors.
• Dividend - Periodic cash distribution from the firm to
the shareholders.
• P/E Ratio - Price per share divided by earnings per
share.
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34. Stocks & Stock Market
• Book Value - Net worth of the firm according to the
balance sheet.
• Liquidation Value - Net proceeds that would be
realized by selling the firm‟s assets and paying off its
creditors.
• Market Value Balance Sheet – Financial statement
that uses market value of assets and liabilities.
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35. Investment Criteria for Valuation
Cash
flow:
Liquidity
Criteria
Safety: Yield:
Level of Expecte
Risk d Return
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36. What Do Different Investors Seek from an
Investment?
Type of What they Expected
Investors Seek Outcomes
BOD of company Expand market share Business Growth
Management Cash flow, partners Liquidity & Job
Security
New markets, Diversification &
Entrepreneurs
undervalued assets growth
Strong mgmt, growth
Venture Capital Capital gains
& value
Fund Mgrs Diversified Portfolio Risk diversification
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37. Investor Risk Return Preferences
• The valuation of an asset reflects the risk-return
preferences of an investor
• Risk and return criteria are largely a personal
phenomenon, and is explained by the “Behavioral
Finance” theory.
• This may explain why some investors prefer safety or
liquidity over return for riskier investments.
• In the end, these preferences will have an impact on
the required rate of return criteria, based on a level of
perceived risk from an investment.
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38. Valuing Common Stocks
• Expected Return –
• The percentage yield that an investor forecasts from
a specific investment over a set period of time.
Sometimes called the market capitalization rate.
• This is the key concept in valuation
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39. Asset Valuation
• Function of both return and risk
– At the center of security analysis
• How should realized return and risk be measured?
– The realized risk-return tradeoff is based on the past
– The expected risk-return tradeoff is uncertain and may not
occur
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40. Measuring Returns
• For comparing performance over time or across
different securities
• Total Return is a percentage relating all dividend
cash flows received during a given time period,
denoted expected Dividends at time t + (Expected
Price of stock „Pe‟ less Beginning price of stock Pb at
b), divided by the start of period price, Pb
Dividendst (Pe Pb )
Total Re turn
Pb
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41. Fundamental Analysis
• Present value approach
– Capitalization of expected income
– Intrinsic value based on the discounted value of the
expected stream of cash flows
• Multiple of earnings approach
– Valuation relative to a financial performance measure
– Justified P/E ratio
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42. Present Value Approach
• Intrinsic value of a security is
n Cash Flows
Value of security t
t 1 (1 k)
• Estimated intrinsic value compared to the current
market price
– What if market price is different than estimated intrinsic value?
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43. Required Inputs
• Discount rate or the Required Rate of Return
– Required rate of return: minimum expected rate to induce
purchase
– The opportunity cost of dollars used for investment
• Expected cash flows
– Stream of dividends or other cash payouts over the life of the
investment
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44. Dividend Discount Model
• Assume a constant growth in dividends
– Dividends expected to grow at a constant rate, g, over time
D1
P0
k g
Where:
– D1 is the expected dividend at end of the first period
– D1 =D0 (1+g)
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45. P/E Ratio or Earnings Multiplier Approach
• Alternative approach often used by security analysts
• P/E ratio is the strength with which investors value
earnings as expressed in stock price
– Divide the current market price of the stock by the latest 12-
month earnings
– Price paid for each $1 of earnings
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46. P/E Ratio Approach
• To estimate share value
P estimated earnings justified P/E rati
o
o
or
P E P /E
o 1 o 1
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47. P/E Ratio
• P/E ratio can be derived from
D1
Po
k -g
or
D1 /E1
Po /E1
k -g
Indicating the factors that affect the estimated P/E ratio 47

48. Important Variables in Valuation
1- Discount Rate
K = Risk adjusted discount rate (cost of capital)
k= Risk Free Rate + Risk Premium
2- Growth Rate
g= Growth rate in earnings
g= ROE * (1 – dividend payout ratio)

49. Which Approach Is Best?
• Best estimate is probably the present value of the
(estimated) dividends
– Can future dividends be estimated with accuracy?
– Investors like to focus on capital gains not dividends
• P/E multiplier remains popular for its ease in use and
the objections to the dividend discount model
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50. Which Approach Is Best?
• Complementary approaches?
– P/E ratio can be derived from the constant-growth version of
the dividend discount model
– Dividends are paid out of earnings
– Using both increases the likelihood of obtaining reasonable
results
• Dealing with uncertain future is always subject to
error
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51. Other Multiples
• Price-to-book value ratio
– Ratio of share price to stockholder equity as measured on
the balance sheet
– Price paid for each $1 of equity
• Price-to-sales ratio
– Ratio of a company‟s total market value (price times number
of shares) divided by sales
– Market valuation of a firm‟s revenues
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52. DIVIDEND DECISIONS
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53. Factors Affecting Dividend Decisions
Constraints on Investment
Dividend Payments Opportunities
Dividend
Decisions
Availability and cost Effects of dividend
of alternative sources policy on cost of
of capital capital
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54. Constraints on Dividend Payments
1. Bond Indentures
2. Preferred Stock Restrictions
3. Impairment of capital rule
4. Availability of cash
5. Penalty tax on improperly accumulated
earnings
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55. Investment Opportunities
1. Number of available profitable
investment opportunities
2. Possibility of accelerating or delaying
projects
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56. Financing: Alternative Sources of Capital
1. Cost of selling new stock
2. Ability to substitute debt for equity
3. Control issues
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57. Effect of Dividend Policy on Cost of Capital
1. Stockholders‟ desire for current versus future
income
2. Perceived riskiness of dividends over capital
gains
3. The tax advantage of capital gains over
dividends
4. The information content of dividends
(signaling effect)
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58. Break Out Session
Participants are divided into two groups (45 minutes)
Group One: (1) Please discuss the four broad sets of
factors that that affect dividend policy in Mongolian
firms. (2) What constraints affect dividend policies?
Group Two: (1) How do investment opportunities affect
dividend policy in Mongolian firms? (2) How does the
availability and cost of outside capital affect dividend
policy?
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59. Summary and Conclusion
 The ultimate goal of the firm is SH wealth maximization. Board is charged
with the strategy formulation and management oversight towards reaching
this goal.
 Good governance is rewarded with a higher market valuation.
 Corporate governance can be improved by pursuing the goal of wealth
maximization.
 Attaining the competitive viability of the firm is an essential element of
governance.
 The firm‟s dividend payout is largely affected by its investment and financing
decisions.
 A number of factors affect dividend decisions, including the corporate
capital structure, the cost of capital and cash flows.
 Implementing globally accepted best practices of corporate governance will
result in achieving better access to finance.
 The active cooperation between firms and stakeholders will create wealth,
jobs and sustain the financially viable enterprises.
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60. The End
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