Fpl Group Case

Intro

FPL Groups major subsidiary, Florida Power & Light Company (FP&L) was formed in 1925; the company enjoyed steady growth until the 1970’s. The chairman at the time decided to diversify into higher growth businesses then introduced a Japanese inspired quality control program to address the problems in operations. When the new chairman was hired in 1989 he scaled back the quality control program and reversed FPL’s diversification program by selling several of the non-utility businesses. By 1994 this strategic redirection was showing signs of success and FPL was the largest utility in Florida. They expected 1994 to be a great year due to decreasing capital expenditures and increasing sales. It was at this point concern was raised about the dividend payout ratio and the possibility of decreasing dividends in the light of recent industry de-regulations.

Dividends

FPL is an investor- owned electric utilities company and dividends are quite important for keeping the loyalty of current investors. Dividends act as the bridge between investors and managers. Appropriation rate of dividends provides more attraction for investors and also offer more opportunities to managers, who can use the invested funds to earn a greater return.

FPL has retained a 47 years streak of dividend increases, which encourages current investors to re-invest the dividends in order to earn an even greater return. This benefits the company as it increases share price. The increased dividends each year sends a positive signal to the market about the firm’s success and more potential investors will join invest in the company, which will result in the stock price increasing even more. Investor return is affected by both dividends and stock price.

Signaling and Clientele Effect

The utility industry has been known for its high dividend payout ratios and dividend cuts were uncommon unless there was a situation of financial instability. There is an issue of information asymmetry between managers and the market especially when it comes to expected net cash flows. The market relies on signaling to distinguish the “good” firms from the “bad” firms. Often a dividend cut sends a negative signal to the market, which causes a decrease in the stock price. This is prevalent in the utility industry and has been seen in the past when companies such as Consolidated Edison Company and Sierra Pacific Resources cut their dividends and their stock prices subsequently dropped by 20-30%. It is likely that this would be the market reaction if FPL were to reduce their dividend even though it is not due to a poor outlook.

Investors have different tax rates for different types of income and these rates vary among different investors. Often investors are attracted to companies stocks that hold policies that align with their investment and tax goals;