Answer 1:

Retained earnings means the profits generated by a company that are not distributed to stockholders but
are either reinvested in the business or kept as a reserve for specific objectives. Cost of retained earnings
means the cost of retaining the funds on the other hand cost of external capital means cost of raising the
funds in the form of equity. Cost of retained earnings will always be less than the cost of equity this is
due to the presence floating cost in case of equity. If there is no floating cost the cost of equity and cost
of retained earnings will be same.

The cost of retained earnings is less than the cost of new outside equity capital. There are no flotation
costs (eg: brokerage) associated with the issuance of new common stock. Thus, cost of retained earnings
is less than the cost of new outside equity capital. Consequently, it is totally irrational for a firm to sell
a new issue of stock and to pay dividends during the same year. Since the cost of retained earnings is
lower than the cost of issuing new shares, a firm should first utilise all of its retained earnings before
raising new capital. Thus, the firm should not pay dividends. The firm should opt to raise more capital
by issuing new stocks only after it has exhausted all its retained earnings. This minimises the cost of
raising capital. Thus, issuing new stocks and paying dividends during the same year results in
unnecessary incurrence of costs of capital and is considered to be irrational.

One pays dividends from retained earnings. If a company wants to pay dividends, and does not have
enough retained earnings to do so, they must raise capital from the outside. A company can only raise
capital by issuing new stock or new debt. There is a cost to raising this capital (together called the
weighted average cost of capital). If the cost of capital is higher than the cost of retained earnings, it
makes no sense to incur excess cost for raising capital just to pay dividends. I feel that it is irrational
for a firm to sell a new issue of stock and to pay dividends during the same time period. To pay
dividends, the firm has to use retained earnings. In the given scenario, the firm does not have enough
of. This means they would have to raise capital to pay the dividends. To sell a new issue of stock would
then mean the firm incurs a cost of raising the new capital.

Answer 2:

It is irrational for a firm to sell a new issue of stock and to pay dividends during the same time period.
To pay dividends, the firm has to use retained earnings. But dividend policies communicate a message
to the investors of the company. Companies that pay dividends regularly communicate that the company
is stable and growing steadily. However, there are a few circumstances in which it would be rational
for a firm to borrow money in order to pay dividends.

 A company that regularly pays out dividends but then experiences a period in which a natural
disaster has occurred. In this scenario the expenses will be in excess of what is covered by
insurances. There will also be reduction in sales and income. But this would be a short term
crisis in the business. In such a case, it would be a good reason for a company to borrow money
to pay dividends, especially if the firm has low debt levels and especially if they are typically
in a strong financial standing condition even after such disaster.
 Another situation would be if a company is rapidly growing. Rapidly growing companies may
face large expansion expenses to generate more business (or to handle large demand for
business) for future for the ongoing of his existing business. Positive cash flows may not be
available when the dividend pay-outs occur, thus it would make sense for companies to borrow
money in this scenario.
 One of the situation is when a company has low retained earnings. This can occur when
dividend payments exceed retained earnings. It can also happen when the company wants to
retain more earnings for some other purpose, such as projects or new investments. If
management decided that forgoing dividend payments would send a negative message, they
may decide to borrow money to pay the dividends. This decision could show signs of
confidence in future cash flows for the company, which may attract more investor interest.
Answer 3:

A primary reason executive compensation has grown so dramatically is that companies have
increasingly moved to stock-based compensation. Such movement is obviously consistent with
the attempt to better align stockholder and management interests. In recent years, stock prices
have soared, so management has cleaned up. It is sometimes argued that much of this reward
is simply due to rising stock prices in general, not managerial performance. Perhaps in the
future, executive compensation will be designed to reward only differential performance, i.e.,
stock price increases in excess of general market increases.

Shareholders rely on CEOs to adopt policies that maximize the value of their shares. Like other
human beings, however, CEOs tend to engage in activities that increase their own well-being.
One of the most critical roles of the board of directors is to create incentives that make it in the
CEO’s best interest to do what’s in the shareholders’ best interests. Conceptually this is not a
difficult challenge. Some combination of three basic policies will create the right monetary
incentives for CEOs to maximize the value of their companies.

The impact of CEO pay towards firm performance brought a positive relationship. When the
performance of a firm increases then the CEO pay would increase too. Mainly because of CEO
pay and firm profitability are directly related to each other. Study that was done by Sigler (2011)
mentioned that there is a positive and significant relationship between CEO pay and company
performance measured by return on equity. However, in Malaysia there still less researcher
performed a study based on this topic. Hence, in Malaysia there may be a result that is totally
different from other research. Based on the uncertainty, there is a motivation to conduct this
study in order to find out the true effects of CEO pay and firm performance.

Using several data sets, the relationship between executive income and firm size is shown to be
relatively stable over time and in different countries. The elasticity of executive earnings to
firm size is about the same today as it was in the 1930s, with evidence of a decline in the
earnings of top executives, controlling for firm size. In addition to the effects of size and other
firm and industry characteristics, there are returns to age and experience. There is also
substantial variability in the level of compensation among firms of comparable size, indicating
that there may be impediments to mobility.

Studies focused on large companies in the United States, Japan and Britain have documented
that there is a strong positive relation between firm size and CEO compensation. They also find
the relation between firm performance and CEO compensation is weak. Executive
compensation of 104 New Zealand firms are examined over the period of 1998 – 2002, and
evidence is obtained consistent with previous studies. Result show that for every percentage
increases in the firm’s total asset, the cash compensation paid to the average CEO increases by
0.39 percent. This result is very close to the finding of many previous studies that identify a
firm-size elasticity between 0.2 to 0.35 for larger U.S., U.K. and Japanese firms. Result also
shows that the firm size elasticity of CEO compensation is greater in larger firms.