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... ge current shareholders to retain their investment in the firm, but also increase the firms attractiveness to potential investors. The disadvantage of paying dividends is that the firm has less money to reinvest. Paying a cash dividend may reflect the firms current success, but it hinders the firms ability to expand. The firm might do better by postponing the payment of a dividend in order to reinvest earnings and take advantage of growth opportunities. A further disadvantage of paying cash dividends is that they are not tax deductible. 4.
Factors of Dividend Cut It is instinctive to consider revisiting the FPL experience. The two reasons that led FPL to cut its dividend were: the recent speed of deregulation in the utilities industry that forced FPL to start thinking about the impact of not being a regulated company, and the fact that the dividend payout had grown to a higher than normal level on a historical basis. The reason for this is that the dividends recently had been growing faster than the company's earnings (1). After these issues were taken into account, there were four major factors that led FPL to simultaneously cut the dividend level and announce a stock repurchase program. First, FPL believed that the negative signal from lowering the dividend would be somewhat offset by the positive signal from a stock repurchase program. Second, there was a tax benefit to a stock repurchase because dividend income is taxed more heavily than capital gains income.
Third, a repurchase program provided flexibility in distributing capital to investors in case earnings were not as high as expected, which stemmed from deregulation within the utility industry increasing FPL's business risk. Fourth, switching to more repurchases and fewer dividends would strengthen the flexibility in the level of cash reserves (2). There are two theories about dividends that are worth explaining in more detail in this paper. Those theories are the Signaling Hypothesis and the Clientele Effect. The Signaling Theory is based off the idea that managers have better information about a firm's future prospects than public stockholders do. Since future dividends are paid out of future profits, and given that managers are reluctant to cut dividends, any change in dividends to be paid is often viewed as a signal of future profits.
Thus, increases in dividends generally result in stock price increases and cuts in dividends generally result in stock price declines (3). The other relevant theory is the Clientele Effect. The basic idea is that different clienteles of stockholders prefer different dividend payout ratios. Firms have different payouts based on their own internal business needs. Thus, when a firm switches its payout ratio, perhaps due to business imperatives, the current clientele leaves and another clientele must come in to take its place.
If more investors leave or if they leave quicker than the new clientele enters, this could lead to a temporarily depressed share price (4). 5. Most Important Issues that Confronted the FPL Group, Inc. in 1994. The most important issues facing the FPL Group in May 1994 are the interrelated concerns of potential competition resulting from industry deregulation and reexamining a high dividend payout ratio. The advent of retail wheeling threatens to reshape the entire electric utilities industry.
The Florida Public Service Commission is not considering a retail wheeling proposal currently, but the general trend in the industry is towards increased competition, and the implementation of such a proposal would expose FPL to numerous competitors and potential losses. The implementation of retail wheeling in California had a severe adverse effect on the three major utilities in that state. The necessity of competing with rival utilities must be a primary concern of FPL given the changing landscape of the industry. FPL needs to ensure that it has the ability to meet the challenge of competition from both in state and out of state providers. FPL Group must reconcile the increasing level of industry competition with its dividend payout policy.
FPL must decide whether to increase dividends, hold dividends constant, or reduce dividends. The company has a streak of 47 consecutive years of dividend increases. Increasing dividends again would be a sign of Fpl's continuing strength in the industry. Increasing dividends seems possible given the companys recent and expected rising sales and declining capital expenditures.
However, FPL has a very high payout ratio, and may need to retain a larger amount of earnings than usual in order to prepare for possible entry into the industry by competitors. Keeping the dividend constant would strike a balance between the need to reinvest earnings in order to expand and the need to mollify shareholders who expect a dividend increase. Cutting the dividend would allow FPL to both reinvest a significant portion of its earnings in order to meet the challenges of the industry's future and offer higher rates of dividend growth in subsequent years. However, cutting dividends would alienate shareholders that expected to receive at least the same dividend as last year. The dividend payout decision implicates Fpl's past, present, and future, and FPL must reach a decision that is consistent with its goals in all three.
Fpl's dilemma is exacerbated by the companys interest expense in the face of rising interest rates. FPL has a large amount of debt, and reducing the dividend could facilitate Fpl's debt repayment. Fpl's stock has fallen dramatically over the period of higher interest rates. Additionally, FPL still holds three unprofitable subsidiaries that detract from Fpl's electricity provider service. These ancillary divisions are all the more incapacitating considering the specter of competition in Fpl's core business.
The concern over the long-term sustainability of supply is another issue facing FPL in light of the fact that Demand grew faster than expected in the late 1980 s, and existing capacity is deemed sufficient only through 2002. All these issues mean that despite Fpl's strength as reflected in its financial statements, the firm faces difficult choices in order to sustain its position as an industry leader. 6. Current Payout Ratio from FPL Perspective. The current payout ratio is too high from Fpl's perspective. FPL needs to secure earnings for reinvestment purposes in order to meet the upcoming challenges to the industry.
FPL cannot afford to pay out 90 % of its earnings given the possible need to expand in the face of newfound competition. Fpl's recent success and optimistic outlook does not mask the fact that the possibility of retail wheeling reduces Fpl's ability to maintain its consistently high payout ratios. Retail wheeling plans are per...
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