The Western Company

Case 80

The Western Company

7. Agency Cost - Agency costs arise because of core problems such as conflicts of interest between shareholders and management. Shareholders wish for management to run the company in a way that increases shareholder value. But management may wish to grow the company in ways that maximize their personal power and wealth that may not be in the best interests of shareholders.

A higher dividend policy would decrease agency costs by reducing free cash flow available to the managers of the firm. If agency costs are reduced that means that management and shareholders are more likely to agree on how the company should be run which would increase the stock price. Also, by increasing the dividend policy it would make the stock more attractive to buyers which would also help increase the price. Agency cost would more likely be an issue for companies where its officers and directors own a small percentage of shares because if they owned a larger percentage then they would want the same things that the other shareholders want. Them having the same interest as shareholders would make them run the company more closely to the way that the shareholders would want it therefore decreasing agency costs.

8a. When setting the target payout ratio Western should consider a few factors such as, the average payout ratio for other companies in the same industry and also what type of investors they are trying to attract and what their current investors’ expectations are. If Western is trying to grow quickly, they may prefer to reinvest more of its income in expanding operations. Western is a more established firm with an established market which means it will most likely not need to expand its operations, and would set their payout ratio higher to compensate its investors.

8b. The dividends should be as possible because having a stable dividend has a positive impact on the market price of the stock. A stable dividend reduces speculation of investors in...