Interactions between Financial Markets, Financial Intermediaries, and Governments - Assignment Example

Q1

Since the beginning of modern capital framework, financial analysts have committed tremendous effort to studying the determinants of corporate policies. Most of the empirical work focused on firm, industry, and market features. Firms that exhibited similar characters often had distinct corporate policies. This pattern has caused researchers to contemporary examine the effect of individual characteristics of the companies’ top executive. Taking inspiration from the behavioral consistency theory, this describes that people behave uniformly across situations, in the article Corporate Policies of Republican Managers; the authors evaluate the connection between the individual political orientation of firm executives and corporate policies. Based on the theory, the authors hypothesize those Republican managers who are more probable to heed conservative personal beliefs would select higher conservative corporate policies (Hutton, Jiang and Kumar 57).

According to past studies, conservatism has been identified as one of the foundations of the Republican Party with 73% following those ideologies. These people show a robust character to preserve the status quo and are prudent about rapid change. On the contrary, the Democratic Party assumes a more liberal perspective with members exhibiting moderate political beliefs. With these facts, the authors incline that individual political ideology of people is potential to influence various elements of their economic behavior. Findings from the study of Political preferences and stock market participation support this notion by indicating that personal political preferences of people affected the investment activities of money managers and individual investors, and the prediction strategies of equity analysts (Kaustia and Sami 66).

The author collects information of firms and managers from multiple sources with the principal being the ExecuComp database for the duration 1992 to 2008. Financial and utilities industry are omitted because they are more dependent on regulation and executives have less control over the choice of corporate policies. Political preferences are determined by the annual managerial, political donations with findings showing that 71.29% of managers contribute consistently to only one party. This pattern signifies that although companies may contribute to political parties tactically to receive favors, donations from managers are highly probable to represent their political ideologies.

The findings are consistent with the authors hypothesize with a corporation having Republican managers exhibiting less risky investments, lower R &D and capital expenses, and lower levels of corporate debt, but having higher profitability, massive retained earnings, and higher magnitudes of dividend payouts. The Republican managers were matched with companies that consisted of conservative political settings. Evidence indicates that political orientation of manager’s influences corporate policies directly using organizational change and firm regressions, and indirectly through executive deaths and managerial turnover. Comprehensively the study reveals that individual political preferences of managers are key factors in molding corporate policies.

As a potential investor, I would not invest in a company that is controlled by a conservative CEO. Because of their prudent attitudes toward risk, they mostly forgo profitable investment opportunities opting for lower investments in intangible and tangible assets that would result in fewer profits. A conservative CEO will not apply high diversified risk because of their caution against rapid change that will be present with many portfolios of investments. Instead, the firm would invest less in R&D and assets, select safer investments, conserve higher earnings, and remunerate higher dividends.

Q2

Although there has been a rapid advancement in technology over the past years, geographic barriers have been indicated to affect information cost of investors and analysts. With the argument that company location influences shareholder capacity to oversee and monitor management, and in turn, corporate dividend policy, in the article Does geography matter? Firm location and corporate payout policy; the authors conjecture that reduced monitoring of executive investment strategies in remotely situated firms increases the likelihood for value damage. Thus to counter this rise in agency expenditures, firms devote higher dividends payouts in advance, especially when they encounter few growth opportunities and high free cash flow. This article contributes to existing literature examining how location affects board composition and CEO power by providing significant new evidence on the capacity of geographic elements impacting firm dividend policies (John, Knyazeva, and Knyazeva 35).

The authors gather data from ExecuComp and Compustat Industrial Annual for the period 1992 to 2006. The sample focuses on analyst forecast data, institutional and insider owner ship, and executive compensation. It excludes small firms with assets value below $20 million, enterprises located or incorporated outside the US, and companies in regulated utilities and financial industries. The measures of the geographic location of a firm are determined by its headquarter being situated in the top ten metropolitan area and the size of potential shareholder site near the company’s locality. Contrary to centrally located corporates, the findings indicate that remotely situated companies are 13% more probable to remunerate higher dividends with a significant variation of 30% of the mean dividend. These facts reveal how location influences the possibility of a dividend change with dividend levels being positively connected with a remote location and negatively linked to central location.

The effect of distance and location on dividends relies on free cash flow, growth, and investment opportunities. Free cash flow problems further enhance the location effect, particularly among companies with huge cash flows and growth options who instinctively pledge to higher dividends. It mostly occurs due to the lack of monitoring managerial decisions because of the remote location that potentially increases the agency cots. Older, bigger, and less risky corporations have fewer growth options and tend to pay higher dividends.

Distance from the shareholder base also influenced dividend payout with remotely located firms exploiting the lack of observation to utilize dividends a sign of prospects. Central location has a higher population density with closer proximity to investors that facilitates surveillance of managerial strategies and reduces agency expenditures. Low population density associated with remote location increases the prevalence of dividend payouts by 13% and the proportion of dividends in remuneration by 11%. Additionally, dividend changes decrease with rising firm age, availability of institutional monitors, and firm risk.

Overall, the study indicates that companies with high free cash flows and few investment and growth options pay higher dividends; also, they may be mature in the industry and are situated in a remote location. On the other hand, firms with closer proximity to shareholders in the central location, with free cash flow issues and many growths and investment opportunities reimburse lower dividends. I would invest in the lower dividend yielding firms since it signifies that the company retains higher earnings that can be utilized in R&D or fund investment activities, in turn, enhancing the company’s value. I would not advocate for the purchase of higher dividend paying stock because most of the company’s revenue is used to pay shareholders rather than grow the company, consequently destroying the firm’s value.

Q3

Political integrity influences the cooperative interactions between financial markets, financial intermediaries, and governments; however, corruption signifies the presence of agency issues between elected authorities and their constituents. It is costly since it retards economic development and financial growth, curtails trade, and impedes transactions. The article Corruption, political connections, and municipal finance explores how political connections and corruption influence principal security market transactions, especially the allocation of municipal bonds. The author acquires information from the Securities Data Company (SDC) regarding municipal bond issues for the period starting 1990 to 2000 and focuses on features such as underwriter identity, years to maturity, issue date, and the jurisdiction. (Butler, Fauver, and Mortal 23).

The findings indicate that political integrity affects credit risk and consequently the pricing of the securities with corrupt states reimbursing higher returns to maturity on their municipal securities. The corruption penalty on revenue varies around 6.6 to 10.5 basis points. Percentage of bonds and state credit rating are connected to credit developments choice whereby jurisdictions with low credit rating are probable to alter the credit standard of the bonds they allocated through buying credit enhancement, a tendency that will continue in the future. It is evident that corrupt states use few reputable underwriters so that it is easy to supply some business to the firms with political affiliations that emerge separately of their pay-to-play donations. Additionally, high reputable underwriters are hesitant to risk their reputation and charge higher rates.

The results indicate that intra-country level is uniform with findings that national-level institutional quality influences sovereign debt returns and ratings. Currently, the new role that financial institutions are playing allows individuals or firms to outsource corruption default risk through offering credit enhancement. Because of handling many bond issues, the organizations are experts at examining risk that can arise from corruption –related activities and political malfeasance. Hence, have a considerable information generation over individual investors. Examining the interaction of underwriters with markets and issuers reveal that although pay-to-play developed the likelihood for favoritism it was principally a medium for the proceeds that the underwriter got in exchange for campaign donations. Furthermore, the findings provide awareness on the way participants in the financial market may handle even serious corruption incidents.

Municipal bonds mature within a duration of 1 to 30 years and are used for financing public projects including utilities, airports, bridges, and roads. They are grouped into two types; one is general obligation (GO) bonds that have support of the issuing organization and are therefore guaranteed. It has a restriction in place on the amount of debt an entity can receive known as debt cap. Second is revenue bond, which does not contain a guarantee or a limit on its indebtedness. While GO bonds are mostly funded by ad valorem returns, revenue bonds are financed from specific assessments, taxes, or fees.

I would invest in revenue bonds that contain higher rates because their reimbursement relies on the outcome of the project. On the contrary, due to their credit guarantee, GO bonds have lower interest rates. I would not invest in municipal bonds from a corrupt state because the investment is most likely not authentic and has lower returns due to the political setting uncertainty. The individual that I will recommend investing in a revenue bond is an ambitious investor who does not avoid risks and diversifies his portfolio.