Ceo Case

Question 1

It would be impossible to say whether the current capital structure and payout policies are appropriate for a company that has been around for more than half a century. Unlike the modern companies where decisions are made mainly to maximize profits and shareholders wealth, BKI has a more family owned and ran feel. Family members of the founders own more than 50% of the shares and the CEO is a grandson of one of the founders. This puts the company in a category in which decisions made may be more on heritage and the values rather than taking risks and maximizing everything.

Historically the company, except on two extreme occasions, never had debt and everything is done with the cash generated from operating activities and cash securities. In case of a buyback using cash and cash securities, the management and board of directors, as well as all the family members, will have an increased holdings in the company. This way BKI will be less vulnerable to pressure from possible acquisition and the proportion of the dividend paid that goes to family members will increase.

All of this is true but as of today’s standards BKI is not able to compete much with its rivals. The company is over-liquid and has no debt, from which the shareholders are suffering because all acquisitions and investments are with high costs and low risks. BKI needs to create leverage by borrowing more, thus increase its ROI and ROE of its acquisitions and investments. At the moment Blain shows the lowest ROE in its sector (by far) while increasing its cost of capital, in other words the cash held remains unutilized and thus reduces the value of the company. Companies with low ROE are less attractive to investors. On the other hand, debt has a much lower cost of capita and provides a good opportunity to take on more investments/acquisitions. It is also enhanced by the tax shield it receives on interest payments, an advantage that BKI does not have at the moment.

The current payout policy undertaken by the company is to increase dividend paid, regardless of whether shareholders value is maximized. This is a wrong approach and BKI should concentrate on what is significantly more important, creating value. It is always good to pay dividend to shareholders as it shows success, but in this case this decision may be biased towards paying more and more instead of measuring success or value creating. Since majority of the shares are held by family members, the board may decide to pay themselves more in the form of higher dividends, instead of investing the amount in projects.

Overall BKI has to make adjustment in order to be even more successful and fit to the picture of the industry. It needs to increase its D/E ratio accordingly in order to be able to gain the advantages rival firms have, instead of holding large sums of cash. As to the payout policy, the company needs to make big changes because it is highly unusual