James Broadheld, chairman of the FPL Group, understood the issues of an ever changing marketplace, and knew that the industry was on the verge of being deregulated, and thus implemented a strategy that focused primarily on a strong commitment to quality as well as customer service, while focusing on the utilities industry and expanding capacity in order to improve its own cost position. He believed that this approach to business would result in a future of full and open competition amongst all competitors.
As a result, as of May 1994, the FPL Group was faced with a critical question to decrease their dividend payout ratio or not? Prior to Broadhelds entry to FPL, chairman Marshall McDonald expanded the types of industries FPL were involved in during the 70s and 80s, leading to extensive diversification. Examples of such industries include real estate and insurance, just to name a few. As Broadheld stepped in, FPLs diversification decreased and as a result the firm saw an improved efficiency. Exhibit 7 revealed that FPLs capacity margin is 8.6%, which is alarmingly low in comparison to the other provided companies. The overall average is approximately 11.39%. This lower capacity margin shows that not much growth is to be expected of the firm, and this is of course relative to other firms.
The same exhibit illustrates cost-management problems. More specifically, FPLs transmission cost of $0.0019/kWh is significantly greater than the other firms provided with an average of $0.0010. Also, considering the fact that the company purchases 30% of the power used from foreign firms, FPLs respective power costs can be high as they are exposed to the risk of changing (and increasing) power prices. The case presented a wide variety of changes in the industrys regulatory standards.
For example, 1992s Wholesale Wheeling allowed companies to buy power from another with the help of a third party. In addition, the Retail Wheeling of 1994 allowed actual customers to not only buy from the monopoly, but from other utility firms (again through third parties). Also, many firms have lost of a substantial amount in market value, including the S&P Electric Utilities Index with a decline of 20%. Turning to an evaluation of the firm, many concerns have been raised over FPLs ever-increasing interest expense since 1993. Analysis
Total earnings are the sum of dividends paid and retained earnings. Dividend-paying firms attract investors. Generally speaking, shareholders either look for growth and/or income when purchasing shares. The former tends to pay less attention to dividend payments and more on the capital gain, whereas the latter prefers a regular income for the investment made. If Kate Stark wishes to revise her current suggestion, she needs to consider the pros and cons in doing so. Focusing first on the negative effects of cutting back on dividends, signalling is undoubtedly one of the biggest issues at hand. Since lower dividend payments may be perceived as a red flag in the companys finances, this information will likely cause a negative reaction in the market. Therefore, concerns in a decreasing stock price are justified.
As for the benefits of lowering the companys dividend policy, the company can now use a larger amount of funds that would have normally been kept aside for dividend payments. This definitely makes changes to the firms financing sources. The money can thus be used for value-increasing projects. From the point of view of an investor, it may not be such a bad idea, considering that dividends are taxed more than capital gains. This results in a potentially large amount of savings for the investors. Also, one of the main benefits of reducing the dividend policy is to lower the risk of market volatility and deregulation.