APC308 Financial Management

APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 ASSIGNMENT COVER SHEET UNIVERSITY OF SUNDERLAND BA (HONS) BANKING AND FINANCE Student ID: 149078874/1 Student Name: Nguyen Thi Kieu Anh Module Code: APC 308 Module Name / Title: Financial Management Centre / College: Banking Academy of Viet Nam Due Date: 15th May 2015 Hand in Date: 15th May 2015 Assignment Title: Individual assignment Students Signature: (you must sign this declaring that it is all your own work and all sources of information have been referenced) Nguyen Thi Kieu Anh APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 Financial Management APC 308 Nguyen Thi Kieu Anh - ID: 149078874/1 Submission date: 15th May 2015 Number of words: 3,500 APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 TABLE OF CONTENTS Part A: Critically analyse and evaluate whether an optimal capital structure does exist I Introduction II Optimal capital structure: Exist or not? David Duran views The traditional view Modigliani-Miller (MM) views 3.1 MM without taxes 3.2 MM with taxes Trade-off theory 4.1 Static trade-off theory 4.2 Dynamic trade-off theory 10 Pecking order theory 11 III Conclusion 11 IV References 17 Part B: Critically evaluate and analyse the three differing strengths of market efficiency 14 I Introduction 14 II Main Body 14 Weak form efficiency 14 Semi-strong form efficiency 15 Strong-form efficiency 16 III Conclusion 17 IV References 17 APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 Part A: Critically analyse and evaluate whether an optimal capital structure does exist I Introduction The capital structure of a firm is the ‘mix of debt and equity financing’ that used to finance its operations (Brealey et al., 2011, p.418) It is generally believed that the capital structure is an important area of the financial management as it influences the shareholders’ wealth In order to achieve the ultimate goal of financial management - shareholders’ wealth maximization, financial managers need to strive to determine the optimal mix of debt and equity in the firm’s capital so that the firm’s value is maximum or the overall cost of capital is minimum Nonetheless, whether or not such optimal capital structure exists for individual companies and businesses still remains a controversial issue in finance There are two schools of thought on this One school supports the existence of the optimal capital structure and other does against it Therefore, this study attempts to shed light of this issue with the support of some empirical findings II Optimal capital structure: Exist or not? David Duran views In 1952, David Duran propounded two opposing views on the existence of optimal capital structure, which is Net Income (NI) approach and Net Operating Income (NOI) approach One important assumption for these approaches is that there is no tax According to NI approach, the cost of equity (KE) and the cost of debt (KD) are independent of each other Since the cost of debt (KD) is usually less than the cost of equity (KE), because debt has prior claim on the firm’s assets and earnings (less risky than equity) (Myers, 2001, p.84), an increase in gearing1 results in reduction of the overall cost of capital (WACC) (Sheeba, 2011, pp.293-294) Figure 1: Net Income Approach (Sheeba, 2011, p.294) Under this approach, a firm can reduce the WACC and increase its value by increasing the proportion of debt in its capital structure to the maximum possible extent That means the optimal capital structure would be 100% debt-financed This approach, therefore, is The proportion of a company’s debt to its equity APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 considered to be no basis in reality (Saravanan, 2010) Converse to NI Approach, NOI approach contends that there is no optimal capital structure for any firm as the proportion of debt and equity in the firm’s capital structure does not have any impact on the firm’s value or its cost of capital (Sheeba, 2011, p.295) Figure 2: Net Income Approach (Bhabotosh, 2008, p.200) The figure illustrates that an increase in the use of cheaper source of debt capital is exactly offset by an increase in the cost of equity (KE) due to increasing financial risk (shareholders face higher risk thereby requiring higher return) The overall cost of capital (WACC), therefore, remains unchanged for all level of gearing The firm’s value also cannot increase by debt-equity mix as a result (Bhabotosh, 2008, p.198) The traditional view Ezra Solomon developed the traditional view2 which lies mid-way between the NI and the NOI approaches It holds that there is an optimal capital structure by increasing the debt proportion in the capital structure to a certain limit (Pandey, 2005, p.316) Figure 3: The traditional view (ACCA, 2009, p.275) Look at the graph above, before point X (low gearing), since the proportion of debt in the capital structure increases within safe limits (either constant or rises slightly), the cost of equity (KE) rise as the reflection of the increased financial risk, but it does not rise fast enough to offset the advantage of low-cost debt Therefore the overall cost of capital Assumptions: No taxes, no transaction costs, net profit are all paid as dividend rather retained APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 (WACC) initially fall and the firm’s value increase (Khan and Jain, 2006, p 9.22) After point X (high gearing), the gearing goes beyond the acceptable limit Bankruptcy risk causes the cost of equity curve rise at a steeper rate and also causes the cost of debt to start to rise Such thing causes increasing WACC and then decreasing the firm’s value (ACCA, 2009, p.82) At the point X (critical gearing), when the rising of the marginal cost of borrowing (KD) is equal to the overall cost of capital (WACC), the firm has reached the optimal capital structure where the overall cost of capital (WACC) is minimised and the firm’s value is maximized (Bhabotosh, 2008, p.201) Horn and Wolinsky (1988) supported traditional view when admitting that a firm could enhance its market price of shares through the use of reasonable leverage (David et al., 2015, p.33) However, Pike and Neale (2006, p.479) stated that the critical gearing ratio is thought to depend on factors such as the steadiness of the company’s cash flow and the saleability of its assets so the concept of optimal capital structure with the critical gearing ratio is “highly desirable but illusory and difficult to grasp” Thus, a firmer theoretical underpinning regarding the optimal capital structure is really needed to facilitate the capital structure decision Modigliani-Miller (MM) views 3.1 MM without taxes In 1958, Modigliani and Miller advanced a theory which supported the net operating income approach and rejected the traditional theory of capital structure (Baral, 2004, p.2)  Proposition I Under supposed conditions of a perfect capital market3, the value of the geared firm (Vg) is the same as that of the ungeared firm (Vug) due to the existence of arbitrage or switching process If the geared firm are priced too much, rational investors will simply borrow on their personal accounts to buy shares in ungeared firms (known as personal or homemade gearing) (Ross et al., 2008, p.430) As long as individual investors can borrow at the same rate of interest as corporations, arbitrage will take place to enable investors to engage in the personal gearing as against the corporate gearing to restore equilibrium in the market (Pandey, 2005, p.319) Thus, firm value is not affected by gearing No taxes, no transaction costs, free information, individual investors can borrow at the same rate of interest as corporations, no other imperfections APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1  Proposition II Figure 4: MM model with no taxes (Pandey, 2005, p.322) Financial gearing causes two opposing effects: it increases the shareholders’ return but it also increases their financial risk In case of the ungeared firm, it is not exposed to financial risk so its cost of equity (Keu) is equal to the WACC In contrast, the levered firm will have higher required return on equity as compensation for the financial risk when the firm gears up The cost of equity (Keg) will increase enough to offset the advantage of cheaper source of debt capital (benefits of cheaper debt is equal to increase in Keg) so the overall cost of capital (WACC) remains constant Go beyond the NOI approach, MM argued that in the extreme gearing, the operating risk of shareholders is transferred to debtholders thereby Ke declines and Kd increases as demonstrated in the graph above (Pandey, 2005, pp.321-322) Proposition I and II draw a conclusion that no optimal capital structure exist However, it should be noted that this theory is only valid only if its strict assumptions regarding a perfect capital market are satisfied But in fact MM’s assumptions would never exist in the real world so MM arrived at invalid conclusion Durand (1959) was the first financial economist criticized MM model on the ground of this issue According to Ross et al (2008, p.439), Modigliani - Miller themselves also have admitted that real-world factors may have been left out of the theory Because of this, Modigliani and Miller (1963) modified their original zero-tax model to include the tax effect 3.2 MM with taxes  Proposition I The previous zero-tax models mentioned that the firm can take advantage of low-cost debt because the debt is less risky than equity Now in the world of taxes, the debt further economizes as it incurs tax advantage (Sheeba, 2011, p.302) The value of the geared firm APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 is equal to the value of the ungeared firm plus the present value of the tax shield in the case of perpetual cash flows Vg = Vug + t × D (1)4 Since the tax shield increase with the amount of debt, the firm can raise its value and lower the WACC by substituting debt for equity (Ross et al., 2008, pp.442-443)  Proposition II Interest paid on debt is tax deductible so it turns KD into KD (1 - t) The cost of debt is even cheaper Figure 5: MM model with taxes (ACCA, 2009, p.279) The increasing gearing increase the cost of equity However, it does not increase as fast as it increases in the no taxes condition The increase in the cost of equity is less than the benefit of interest tax shield on debt (Sheeba, 2011, p.303) Such thing results in declining in the overall cost of capital (WACC) and increasing the firm’s value The optimal capital structure is reached when the firm employs almost 100% debt (Pandey, 2005, p.325) Unfortunately in practice the firm does not employ extreme level of debt because of tax advantage The reason is showed by Miller (1977) that MM model ignored the impact of personal tax for corporate borrowing The personal income tax paid by the debt holders on interest income may completely offset the advantage of interest shield Besides, some financial economists also criticised that MM model ignored the financial distress costs (including bankruptcy cots of debt and agency costs) In the extreme gearing, these costs may also eliminate benefits of tax shield Hence, it can be said that MM model actually overstates the value of gearing (Pandey, 2005, p.325) Even so, despite the criticism of MM’s framework, MM still stands as a corner of corporate finance because it acts as Vg = the value of a geared firm, Vug: the value of an ungeared firm (no debt), t: the corporate tax rate, D: the level of debt in the capital structure APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 paving the way for the development of several theories of capital structure, namely tradeoff theory (Jensen, 2013, p.7) Trade-off theory Unlike MM theory, the firms should take on as much as debt as possible, trade-off theory avoids extreme predictions and rationalize moderate debt ratios (Jahan, 2014, p.12) 4.1 Static trade-off theory Models of static trade-off are connected to the bankruptcy costs and agency costs  Trade-off models related to bankruptcy costs This model is presented by Baxter (1967) and Krause and Litzenberger (1973) It suggests the optimal capital structure exists and is determined by the achievement of balance between tax benefits and costs of debt (Ghazouani, 2013, p.626) Figure 6: Static trade off theory of capital structure (Myers, 1984, p.577) The tax shield increases the value of the geared (levered) firm Bankruptcy costs lower the value of the geared (levered) firm The two offsetting factors produce an optimal amount of debt as point X in the figure above (Ross et al., 2008, p.465)  Trade-off models related to agency costs According to Jensen and Meckling (1976), agency costs arise due to conflicts of interest among management, shareholders and debt-holders Conflict occurs between management and shareholders which leads to agency cost of equity Such conflicts occur when management’s objectives are not fully aligned with those of shareholders Since the company issues debt, conflict arises between debt-holders and shareholders that lead to agency cost of debt Such conflict occurs when debt-holders imposes restrictive covenants on the firm through debt agreement that prevent the manager from investing in high risk project because the debt-holders not receive a return which compensates for engaging APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 in that risky project Consequently, it prevents the firm’s growth and earnings to shareholders (Sheeba, 2011, p.306) Figure 7: Agency costs of debt (Jensen and Meckling,1976, p.55) A trade-off between the agency costs of equity and the agency costs of debt produce an optimal capital structure In other word, the optimal capital structure can be achieved by finding the point where the total cost of agency costs is minimum (the agency costs of debt is equal to the agency costs of equity) (Ghazouani, 2013, p.627) Empirical findings on static trade-off theory conclude mixed results On one side, many studies showed that target leverage is not important For instance, Titman and Wessels (1988), Raijan & Zingales (1955) and Fama & French (2002) affirmed that higher profitability firms tend to borrow less that is inconsistent with the actual trade-off prediction that higher profitability firms should borrow more to reduce tax liabilities Graham (2000) estimated the cost and benefit of debt finds that the large and more profitable firms with low financial distress expectation use the debt conservatively and Microsoft is an typical example (Jahanzeb et al., 2014, p.13) On the other side, several studies support trade-off theory and confirm the role of target leverage, namely Marsh (1982) provided evidence companies appear to make their choice of financing instruments as if they have target levels of debt in mind Furthermore, Walsh and Ryan (1997) found both agency and tax considerations were important in determining debt and equity issues But Lasfer (1999) investigated that the relationship between debt and agency costs only applies to large companies whereas small company debt appears to be driven by profitability (Beattie et al., 2006, p.6) 4.2 Dynamic trade-off theory The increasing dissatisfaction of static trade-off theory leads to the birth of dynamic trade-off theory It is firstly introduced by the Fischer, Heinkel and Zechner (1989) and further developed by Strebulaev (2007) It is assumed that the costs of constant capital adjustment 10 APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 are high and thus firms let their gearing ratios vary within an optimal range instead of specific optimal point as stated in static trade-off theory Firms will adjust their gearing only if it reaches the boundary of the optimal range where benefits exceed costs (Burkhanova et al., 2012, p.1) Pecking order theory The pecking order theory is developed by Myers (1984) and Myers and Majluf (1984) They captured the effect of asymmetric information that arises between managers and investors of the company upon the mispricing of both debt and equity (Lima, 2009, p.3) To avoid this problem arising and becomes profitable firms, firms prefer internal funding over external funding In case firms require external funding they would prefer debt over equity and equity is generated as last resort (Sheikh et al., 2012, p.87) Contrary to the trade-off theory, the pecking order theory has no predictions about the optimal capital structure Instead its implications are that the companies will issue or retire debt and equity in accordance to its funding requirements (Jensen, 2013, p.15) Empirical evidences surrounding this theory are also mixed Pecking order theory is supported by Mullins (1986) and Eckbo (1986) who had shown evidence of adverse selection relating to equity issues and Fama and French (2000) who found that profitable firms were less levered as compared to non-profitable firms (Sheikh et al., 2012, p.87) In contrast, Hamid (1992) and Sigh (1995) stated that in developing countries, there is an inverse pecking order as corporations rely heavily on external financing, especially stock issues and shortterm finance Chittenden et al (1996) also supposed that firms are willing to sell equity when the market overvalues (David et al., 2015, p.37) III Conclusion Empirical researchers have tried to offer different perspectives and assumptions to prove the existence or non-existence of capital structure However, from analysing and evaluating two schools of thought above, it can be concluded that no theory becomes dominant Despite of this, the subjective viewpoint of the author supposed that an optimal capital structure may exist but a range of optimal capital structure is more likely to exist in practice A firm can employ suitable proportion of debt to take advantage of tax shield and less risky financing source as long as it does not beyond acceptable limit to ensure that the company avoids financial distress circumstances 11 APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 IV References ACCA (2009) ACCA Paper F9: Financial Management London: BPP Learning Media Ltd ACCA (2009) Optimum capital: Relevant to ACCA qualification paper F9 Available at: http://www.accaglobal.com/content/dam/acca/global/PDFstudents/2012s/sa_junjul09_lynch.pdf (Accessed: 09 April 2015) Baral, K.J (2004) Determinants of Capital Structure: A Case Study of Listed Companies of Nepal The Journal of Nepalese Business Studies, 1(1), pp.1-13 Beattie, V and Goodacre, A and Thomson, S.J (2006) Corporate financing decisions: UK survey evidence ournal of Business Finance and Accounting, 33(9-10), pp.1402-1434 Bhabotosh, B (2008) Fundamentals of Financial Management New Delhi: PHI Learning Private Limited Brealey, R A., Mylers, S C and Allen, F (2011) Principles of Corporate Finance New York: McGraw-Hill/Irwin Burkhanova, A., Enkov, V Korotchenko, D A., Kichkaylo, M V., Marchenko, K Y., Rozhdestvenskaya, A L., Smirnova, I N and Ulugova, A E (2012) Dynamic Trade-off Theory of Capital Structure: an Overview of Recent Research Journal Corporate Finance Research , 3(23), pp.70-86 David, B., Attipoe, K K., France, K, O., and Kopodo, B B (2015) The Effect of Capital Structure on profitability of Listed Manufacturing Firms in Ghana Durand, D (1959) The Cost of Capital, Corporation Finance, and the Theory of Investment: Comment American Economic Review, 49(4), pp.639-55 Ghazouani, T (2013) The Capital Structure through the Trade-Off Theory: Evidence from Tunisian Firm International Journal of Economics and Financial Issues , 3(3), pp.625-636 Jahan, N (2014) Determinants of Capital Structure of Listed Textile Enterprises of Bangladesh Research Journal of Finance and Accounting, 5(20), pp.1-20 Jahanzeb, A., Rehman, S U., Bajur, N H., Karamand, M., and Ahmadimousaabad, A (2014) Trade-Off Theory, Pecking Order Theory and Market Timing Theory: A Comprehensive Review of Capital Structure Theories International Journal of Management and Commerce Innovations (IJMCI), 1(1), pp.pp.11-18 Jensen, M C., and Meckling, W.H (1976) Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure Journal of Financial Economics, 3(4), pp.305-60 Jensen, A.W.H (2013) Determinants of capital structure: An emprical study of danish listed companies Aarhus University 12 APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 Khan, M Y and Jain, P K (2006) Cost Accounting and Financial Management New Delhi: McGraw-Hill Publishing Company Limited Lima, M (2009) An Insight into the Capital Structure Determinants of thePharmaceutical Companies in Bangladesh Miller, M.H (1977) Debt and Taxes Journal of Finance, 32, pp.261-75 Myers, S C (1984) The capital structure puzzle Journal of Finance, 34, pp.575-92 Myers, S.C (2001) Capital Structure Journal of Economic Perspectives, 15(2), pp.81-102 Pandey, I.M., 2005 Financial Management New Delhi: VIKAS Publishing House Pvt Ltd Pike, R and Neale, B (2006) Corporate finance and investments: Decisions and strategies Harlow: Pearson Education Limited Ross, S A., Westerfield, R W., Jaffe, J and Jordan, B D (2008) Mordern Financial Management New York : Mc Graw Hill/ Irwin Saravanan (2010) Capital Structure Definition Available at: http://www.slideshare.net/saravanan25/capital-structure-defenition (Accessed: 02 April 2015) Sheeba, K (2011) Financial Management India: Dorling Kindersley Pvt Ltd Sheikh, J., Shakeel, A W., Iqbal, W., and Tahir, M M (2012) Pecking at Pecking Order Theory: Evidence from Pakistan’s Non-financial Sector Journal of Competitiveness, 4(4), pp.86-95 13 APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 Part B: Critically evaluate and analyse the three differing strengths of market efficiency I Introduction Efficient market hypothesis (EMH) is partly developed by Eugene Fama in 1960s It states that the price of a security fully and fairly reflects all available and relevant information so it is pointless trying to predict trends in the market through fundamental analysis or technical analysis (Fama, 1970, p.388) Most investors also believed that the securities they are buying are worth more than the price that they are paying, while securities that they are selling are worth less than the selling price But if markets are efficient, actually they are engaging in a game of chance rather than skills (Karz, 2011) This study will help better understand about EMH through evaluation and analysis of three differing strengths of market efficiency II Main Body Three differing strengths of market efficiency include weak form, semi-strong form and strong form which is divided based on the definition of the available information set Weak form efficiency A market is considered as weak form efficient if current prices fully reflect all information contained in historical prices, which implied that no investor can devise a trading rule based solely on past price patterns to earn abnormal returns (Poshakwale, 1996, p.605) The future share price movements depends on new information, since new information arrive at random, no investor can predict it is good or bad news so share price movements is completely random The weak form of EMH was supported through evidence provided in many empirical studies that focus on the random walk hypothesis (RWH) This random walk hypothesis asserts that price movements will not follow any patterns or trends and that past price movements cannot be used to predict future price movements (Karz, 2011) Evidence supporting the random walk model is the evidence of weak-form efficiency market, but not vice versa (Ko and Lee, 1991) Empirical studies of weak form efficiency used serial correlation tests, run tests and filter tests Kendall (1953) examined the behaviour of weekly changes in 22 British industrial and commodity share price indices The study supported random walk on zero correlation rationale Kendall concluded that investors could not make money by watching price movements This conclusion had been suggested earlier by Working (1934) through investigation of small sample (Shamshir and Mustafa, 2014, p.4) Fama (1965) applied serial correlation test, run test technique to daily data of thirteen individual stocks listed in the 14 APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 Dow-Jones Industrial Average (DJIA) in the period of years (from 1956 to 1962) He found a very small positive correlation, which was not statistically different from zero, while the number of runs was smaller than expected which indicates that the positive correlation found by the serial correlation test Both tests show that the independence in successive price changes in either extremely small or nonexistent (Kiruri, 2009, p.12) Alexander (1961) applied filter techniques to series of daily closing prices for each of the individual securities of the Dow-Jones Industrial Average to figure whether the technical trading rule can beat the buy-and-hold strategy Alexander’s conclusion is that the results of the filter rule technique could provide abnormal returns compared with a simple buy and hold strategy; gains were cancelled out when transaction costs were taken into account (Watson and Head, 2007, p.37) Hence, it is concluded that all these empirical studies support weak-form efficiency market Nonetheless, calendar anomalies produce evidences against weak-form market efficiency Some empirical studies showed that stocks have performed better in certain time periods thereby investors can earn abnormal return Smirlock & Starks (1986) found that stock have historically performed better on Fridays than on Mondays (the weekend effect) Studies of Keim (1983) document the phenomenon of small-company stocks to generate more return than other asset classes and market in the first two to three weeks of January (January effect) (Latif et al., 2011, p.6) Abnormal preholiday returns on U.S stocks have been documented by Merrill (1965) and Fosback (1976) (the holiday effect) For instance, Fosback (1976) reports high preholiday returns in the S&P 500 index (Kim and Park, 1994, p.145) These anomalies are difficult to reconcile with the EMH because of it regularity and publicity (Lo, 2015, p.8) Semi-strong form efficiency Semi-strong form of EMH suggests that current market prices reflect not only past prices but all other publicly available information as well If a market is semi-strong form efficient, stock price will either response immediately with announced news or no response at all because announced news is not necessary information Therefore, it is impossible for investors to achieve excess return by using fundamental and technical analysis (Brigham and Dave, 2013, p.190) The traditional argument for the semi-strong form efficiency is a timely and accurate stock price adjustment after key announcement (stock splits, anticipation of annual reports and mergers and acquisitions…) The research of stock price changes after the key announcement is known as event studies (Degutis and Novickytė, 2014, p.12) Event study, undertaken by Fama, Fisher, Jensen and Roll (FFJR 1969), produce useful evidence on the effects of announced stock splits on stock prices FFJR concluded that abnormal returns 15 APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 are flat after month of split and cumulative abnormal returns can be attributed to the fact that stock splits usually take place following a rise in stock price during ‘good times’ Similar studies conducted by Ball and Brown (1968) and Rendleman, Jones and Latane (1982) on dividend and earning announcements generally concluded that only unanticipated announcements cause significant abnormal returns The result of Keown and Pinkerton (1981) showed that the information was already reflected in the share price These findings are strongly support semi-strong efficient market (Uh, 2006, p.163) However, there is some event studies offer evidence of anomalies against semi-strong form efficient market Beechey et al (2000) observed that share prices continue to rise (or fail) for substantial period following the release of positive (or negative) information Manganelli (2002) found that the more frequently a share is traded, the shorter time required for its price to return to equilibrium having absorbed new information (Watson and Head, 2007, p.38) Strong-form efficiency Strong form efficient market stated that current prices fully reflect all publicly and privately information It means that neither investors relying on generally available information nor those having access to non-public information can ‘beat the market’ and achieve abnormal rates of return (Potocki and Świst, 2012, p.160) It is possible to test for strong-form efficiency directly by investigating the market’s use of insider information as this information is not publicly available Tests for strong form efficiency are therefore indirect in approach: they examine how expert users of information perform when compared against a yardstick such as the average return on the capital market (Watson and Head, 2007, p.38) One of the first publications evaluating returns achieved by investment funds was the analysis of 115 investment funds over the years 1954-1964, undertaken by Jensen (1969) The results of the analysis showed that investment fund almost did not make above-average returns when investment management fees and expenses were taken into account Similar results are showed by Megginson (1997) and Beechey et al (2000) Nevertheless, Jaffe (1974) produced contrary results that it is possible to achieve profits superior to the market average by using non-public information Koewn and Pinkerton (1981) provided evidence for achieving abnormal rates of return by insiders before the public announcement of planned mergers These results obviously rejected the hypothesis of the strong form efficient market (Potocki and Świst, 2012, p.160) Whether or not market is strong-form efficient, using insider information to beat the market obviously is illegal It is considered as a form of securities fraud 16 APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 Generally speaking, investors are not capable of constantly beating the market as investment fees, taxes, human emotion working against them; they are more likely to so through luck Peter Lynch and Warren Buffet are exceptionally lucky that have consistently been the market over long period of time (Fontinelle, 2015) III Conclusion The concept of EMH showed that stock returns are random and investors are unable to earn abnormal return in such a market EMH was considered as absolutely truth in the eighties However, from analyzing and evaluating of three differing strengths of market efficiency, it is easy to recognize that EMH fails to explain some anomalies arising in the market so it is now seen as relative truth IV References Brigham, E and Daves, P (2013) Intermediate Financial Management 11th edn USA: South-Western Cengage Learning, pp 189-191 Degutis, A and Novickytė, L (2014) 'The efficient market hypothesis: A critical review of literature and methodology', EKONOMIKA, 93(1), pp.7-23 Fama, E.F (1970) 'Efficient capital markets: A review of theory and empirical work', The Journal of Finance, 25(2), pp.383-417 Fontinelle, A (2015) Is it possible to beat the market? Available at: http://www.investopedia.com/ask/answers/12/beating-the-market.asp (Accessed: 24 April 2015) Karz, G (2011) The Efficient Market Hypothesis & The Random Walk Theory Available at: http://www.investorhome.com/emh.htm (Accessed: 22 April 2015) Kim, C W and Park, J (1994) 'Holiday Effects and Stock Returns: Further Evidence', The Journal of Financial and Quantitative Analysis, 29(1), pp.145-57 Kiruri, S (2009) Stock market reactions to macro-economic annoucements in Kenya: A case of stock prices at the NSE A management research paper Business university of Nairobi Ko, K S and Lee, S B A (1991) 'A comparative analysis of the daily behaviour of stock return: Japan, the U.S and the Asian NICs', Journal of Business Finance and Accounting, 18(2), pp.219-34 Latif, M., Arshad, S., Fatima, M and Farooq, S (2011) 'Market Efficiency, Market Anomalies, Causes, Evidences, and Some Behavioral Aspects of Market Anomalies', Research Journal of Finance and Accounting, 2(9,10), pp.1-13 17 APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 Lo, A.W (2015) Efficient Market Hypothesis Available at: http://web.mit.edu/Alo/www/Papers/EMH_Final.pdf (Accessed: 23 April 2015) Poshakwale, S (1996) 'Evidence on Weak Form Efficiency and Day of the Week Effect in the Indian Stock Market', Finance India, 10(3), pp.605-16 Potocki, T and Świst, T (2012) 'Empirical test of the strong form efficiency of the Warsaw Stock Exchange: The analysis of WIG 20 index shares', South-Eastern Europe Journal of Economics , 10(2), pp.155-72 Shamshir, M and Mustafa, K (2014) 'Efficiency in stock markets: A review of literature', International Journal of Economics, Commerce and Management, 2(12), pp.1-22 Uh, R.S (2006) Financial Institutions and Services New York : Nova Science Publishers Watson, D and Head, A (2007) Corporate Finance: Principles and Practice Harlow, England: Pearson Education Limited 18 ... 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 Financial Management APC 308 Nguyen Thi Kieu Anh - ID: 149078874/1 Submission date: 15th May 2015 Number of words: 3,500 APC 308 Financial. .. important area of the financial management as it influences the shareholders’ wealth In order to achieve the ultimate goal of financial management - shareholders’ wealth maximization, financial managers... the company avoids financial distress circumstances 11 APC 308 Financial Management Nguyen Thi Kieu Anh - ID 149078874/1 IV References ACCA (2009) ACCA Paper F9: Financial Management London: