Dr. Demir Yener, Senior Corporate Governance and Finance Advisor, USAID/BPI Project, Ulaanbaatar, Mongolia

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

2. 22
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
Purpose: To explain the role of the board in determining
dividend, investment and financing policies to achieve the
shareholder wealth maximization objective.

3. 33
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

4. 44
Strategic Role of the Board of Directors
Revisited

5. 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.”
5

6. 6
Key Fundamentals of CG Environment
Four Values of Corporate Governance
Transparency Accountability Responsibility Fairness

7. Ownership vs. Management
Information Needs
• Stock prices
• Returns on
investment
• Issues of shares
and other securities
• Dividends
• Financing
Different Objectives
• Managers vs.
stockholders
• Top mgmt vs.
operating mgmt
• Stockholders vs.
creditors
7

8. Financial Markets
Funds
Primary
Markets
Second
ary
markets
OTC
markets
8

9. Interactions Between Financial Market Participants
Financial
Markets
Issuers
Investors
Intermedi
aries
9

10. Good Governance Improves Performance
• Disclosure of financial position helps set clear targets
• Holds all employees responsible and accountable for results
Disclosure and Transparency
• Checks on executive management
• Brings market perspective on risk
Audit Committee
• Critical for creating the right incentives to ensure the success of strategies
Management Compensation Committee
• Bring fresh and objective perspective to board decision making process
Independent Directors
1010

11. 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
11

12. 1212
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

13. 1313
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.

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.”
14

15. 15
The Goal of the Firm
To maximize the wealth of shareholders.
15

16. 16
Motivation to Invest
Why invest in a company?
16

17. 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
17

18. 1818
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

19. 1919
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.

20. 2020
Dividend, Financing and Investment Policies
Dividend, Investment and Financing Decisions

21. 21
Three Wealth Maximizing Decisions of the Board
Investment
DividendFinancing
 The optimal
combination of the three
policy decisions ensure
value maximization.
 Executive management
is responsible for
implementing the
wealth maximizing
policies for
shareholders
21

22. CORPORATE FINANCE FRAMEWORKINVESTMENTPOLICY
• Allocating
capital
• Ensuring
operational
efficiencies
• Creating S/H
value (Wealth
maximization)
FINANCINGPOLICY
• Implementing
Investment-
Finance-
Dividend
Policies
• Capital
Budgeting
(Investment
Decisions)
• Cash Budgeting
(Operational)
MARKETS
• Issue securities
for LT Funds
from investors
(Bonds and
Stocks)
• Raise ST
Funds from
banks
12
3 4
5
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
22

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

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

25. 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)
25

26. VALUATION
26

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.
27

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)
28

29. What Is The Purpose Of Value Creation?
29
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

30. Scenarios For Uses Of Valuation
30
• 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

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

32. Methods Of Business Valuation
• Adjusted Book Value
• Net Asset Value
• Replacement Value
• Liquidation Value (break-up value)
Asset Based Valuation
• The Earnings Multiplier Method (P/E)
• Payback Method
• Discounted Cash Flow Method (DCF): a.k.a. the “income
capitalization method
Going Concern Value
32

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.
33

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.
34

35. Investment Criteria for Valuation
Criteria
Cash
flow:
Liquidity
Yield:
Expecte
d Return
Safety:
Level of
Risk
35

36. What Do Different Investors Seek from an
Investment?
Type of
Investors
BOD of company
Management
Entrepreneurs
Venture Capital
Fund Mgrs
What they
Seek
Expand market share
Cash flow, partners
New markets,
undervalued assets
Strong mgmt, growth
& value
Diversified Portfolio
Expected
Outcomes
Business Growth
Liquidity & Job
Security
Diversification &
growth
Capital gains
Risk diversification
36

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.
37

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
38

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
6-39

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
P
)P(PDividends
turnTotal
b
bet 
Re
6-40

41. 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

42. 42
• Intrinsic value of a security is
• Estimated intrinsic value compared to the current
market price
– What if market price is different than estimated intrinsic value?




n
t
t
k)(
Cash Flows
uritysecValue of
1 1
Present Value Approach

43. 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

44. 44
• Assume a constant growth in dividends
– Dividends expected to grow at a constant rate, g, over time
Where:
– D1 is the expected dividend at end of the first period
– D1 =D0  (1+g)
gk
D
P

 1
0
Dividend Discount Model

45. 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

46. 46
• To estimate share value
11
/E
o
PE
o
P
or
oP/E ratijustifiedearningsestimated
o
P


P/E Ratio Approach

47. P/E Ratio
• P/E ratio can be derived from
or
Indicating the factors that affect the estimated P/E ratio 47
k - g
D
Po
1

k - g
/ED
/EPo
11
1 

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. 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

50. 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

51. 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

52. DIVIDEND DECISIONS
52

53. TREATMENT OF DIVIDENDS IN COMPANIES LAW
CHAPTER SIX: DIVIDENDS
Article 46. Payment of Dividends
• Stipulates that the Board of Directors or in its absence, the
shareholders meeting, shall decide the matter of paying dividends and
the amount of the dividend to be paid per share, the date for issuing the
list of shareholders entitled to receive dividend, and the dividend
payment date.
Article 47. Conditions With Respect to Payment of
Dividends
• Stipulates that a company shall pay dividends with respect to its
common shares so long as the company remains solvent after payment
of the dividend.

54. Factors Affecting Dividend Decisions
Constraints on
Dividend Payments
Investment
Opportunities
Availability and cost
of alternative sources
of capital
Effects of dividend
policy on cost of
capital
Dividend
Decisions
54

55. A Five-stage Life-Cycle Model
55
1. Development Stage
2. Market Introduction
3. Growth Stage
– High earnings growth
– Low dividend payout ratio
– Transition Stage
• Slower earning growth
• Increasing dividend payout ratio
4. Maturity Stage
– Stable earnings growth
– Stable dividend payout ratio
5. Decline
The challenge is not only to accurately forecast the earnings
growth and payout ratio values for each segment, but also to
estimate the duration of each of the first two stages.

56. 5656
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

57. 5757
Investment Opportunities
1. Number of available profitable
investment opportunities
2. Possibility of accelerating or delaying
projects

58. 5858
Financing: Alternative Sources of Capital
1. Cost of selling new stock
2. Ability to substitute debt for equity
3. Control issues

59. 5959
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)

60. 6060
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?

61. 61
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.
61

62. 6262
The End