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  • Using theoretical and empirical evidence, critically discuss how signalling theory explains a managers decision to change capital structure and payout policy. Analyse how the stock market responds to the decisions

Using theoretical and empirical evidence, critically discuss how signalling theory explains a managers decision to change capital structure and payout policy. Analyse how the stock market responds to the decisions – Essay Example

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Cost appears to be major factor in the signalling theory. This is because prior to making any decisions, managers need to consider the expense. At times, some signals may be deceiving and may later affect the decisions made adversely in a negative way. For example, the target earnings of the business may seem promising in the next quarter of the business thereby making the manager decide on a high pay out percentage. This signal could be truthful or deceiving and will eventually impact on the decision made for pay outs. On the other hand, deceptive signals can be used to benefit the creator of the signal.

For instance, a manager can signal stakeholders and potential investors that the organization is well off to making more profits by increasing the payout ratio for their dividends. This would make them invest more in the organization and thus, enable the manager to expand the business and increase profits (Pacheco & Raposo 2007). Managers face the basic responsibility of deciding on the amount to debt to be employed on the capital structure as well as determine the dividend percentages to be paid out (Barclay et al.

1992). Different theories have been established to identify the aspects that are relevant in identifying capital structures and payout policies. Among these is the signalling theory. Aside from cost, taxes have also been noted to be a vital aspect that affects the capital structure and payout policies of organizations. Taxes impact on the worth of an organization. This is evidenced in the amount of deductions made to make payouts as well as in the way an organization dispenses its cash flow.

For instance, by minimizing debt in the capital structure, an organization stands to reduce its tax liabilities and eventually enhance its cash flows. This essay will focus on the role that signalling theory plays in relation to decision making. Managers are always in touch with the organizational operations and performance. This factor contributes largely to the impact their decisions have on the capital structures and payout policies being implemented by the organization. Signalling and the Capital Structure The capital structure of an organization depends on the techniques implemented by managers to fund the organization’s operations.

Most organizations use stocks and bonds. Debt as well as an organization’s equity varies in different modes. These modes offer a basis for signalling by the manager. For instance, agreements on debt usually necessitate an organization to turn a fixed deposit of funds payments above the life of a credit.

References

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