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Running head: MARKET EFFECIENCY 1

Shareholders will never know our capital budgeting decision

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MARKET EFFECIENCY 2

Shareholders will never know our capital budgeting decision

Shareholders represent a unit of ownership within a business entity. This unit is entitled

to the procedures of the entity subject to the preferences the type of shareholding entails.

Shareholders form a part of the obligation the board of directors focuses on appeasing in

maximizing their wealth and profits. Concurrently, managerial decisions affect the

implementations and scope of financial functions by inculcating directives on long-term asset-

mix decisions, financing decisions, division of earnings and the liquidity decisions (Brigham &

Houston, 2012). Therefore, decisions by the corporate managers directly affect the market

efficiency hypotheses. Market decisions vary from an allocative basis to operational and

informational base. The shareholders and managers may differ in their agency relationship where

conflicting interest prevail. Mangers would perpetuate this conflict in instances where they

incorporate decisions that foresee undertaking of projects risky than what shareholders term as

reasonable. Moreover, mangers can undertake projects that advance the imagery of the company

at the expense of profitability. However, a company trying to figure out the appropriateness of

time to disburse dividend or revalue securities would consider allocation efficiency, operational

and information efficiency to fit an accurate model that reflects the effectiveness of the market.

Capital budgeting procedures entail the evaluation of projects that a firm has interest in to

scrutinize the viability of the project’s financial implication (Mathuya, 2015). Sequentially,

projects that imply maximum utilization of resources are adopted, and financing options are put

in place. When carrying investment decisions, firstly, business firms identify the project of

evaluation. Secondly, they define and screen the purpose and objectives of the project, thirdly,

analysis and acceptance, fourthly, implementation of the project and finally the monitoring

process precedes an audit report. Contentiously, sidelining the shareholders from capital

MARKET EFFECIENCY 3

budgeting decisions deludes a falsification of the securities traded by the firm to the market.

However, an efficient market structure realigns the disparity to gather the correct market values

of the securities. McWilliams, Siegel & Wright (2006) argue that firms guise the intention to

allure investors to a new investment option by deploying capital budgeting statements.

Nonetheless, these provisions are counteracted by the systemic strengths found within an

efficient market.

As earlier envisaged, efficient market hypothesis relay allocation, information, and

operational proficiency. Information on the market trends can take a weak form hypothesis, a

semi-strong hypothesis or a strong form hypothesis. Weak form level of efficiency states that

share prices reflect the information of historical price movement and patterns entirely (Yalcin,

2010). For example, if a company’s share prices have increased steadily to a specific figure, then

the market reflect substantial information which is used to predict future movements anticipated

by the shareholders.it stands that investors would not count on charts and technical analysis to

make arbitrage profits with this kind of random walk. Yalcin (2010) adds that Semi-strong form

of market efficiency provides past and current information on the trends of security prices such

that investors cannot make arbitrage profits consistently. In this form of market efficiency, a

fundamental analysis could be used to derive an asset’s intrinsic value which reflects the

theoretical value of companies financing securities. Consequentially, investors can find an

undervalued asset through fundamental analysis. Strong form market efficiency hypotheses

argue the presence past present and future information within the market prices pattern. Prices

scope all the public and private information available. Investors in this form have a better

prospecting ability than their fund managers. Insider trading is a causative factor when markets

MARKET EFFECIENCY 4

adjust to strong form efficiency. A market embattled by this state would only provide the fund

managers an option of maximizing the NPV of each project to maximize shareholders wealth.

Synchronously, the capital budget goes hand in hand with deliberations of the market

efficiency so that the measures of a project’s riskiness can materialize. Factually, the tools for

decision making in capital budgeting requires the use of trending analytical market rates

(Mathuya, 2015). For instance, the typical methods of carrying an evaluation require a project to

determine its payback period, the net present value and the internal rate of return. NPV require

the computation of cash inflows and the cash outflows whereby their difference infers the Net

Present Value. Kida, Moreno & Smith (2001) state that cash inflows refer to cash generated by

the project while cash outflows deduce the cost anticipated on implementing the project.

However, the rate of return needs to reflect similarity with the rates in the markets. The

efficiency of the market should provide an adequate rate of return from the firms that have

engaged in similar project evaluations for the investment firm to make an informed decision. Say

on its NPV. Otherwise, the investment firm would evaluate on the wrong basis. Still, if the

market is inefficient, evaluation takes a falsified pattern, and the reflective financing options will

infer losses. Evidently, considering the strong market efficiency, shareholders get the anticipated

information even before investing. Such phenomenon places corporate managers in a

compromising situation because the capital budgeting decision they intend to take may not be

sufficient enough to guarantee maximization of wealth and profits.

Undoubtedly, the statement, shareholders will never know our capital budgeting

decisions is a subjective one to different market spectacles. Well, the inside structure, under

weak and semi-strong market efficiency, reveals absolutely moderate information to the market

in which we can contend that the likelihood for shareholders to perceive the intended capital

MARKET EFFECIENCY 5

budgeting decisions are null and void. Contrastingly, as depicted within the strong market

efficiency, insider information can be relayed to the shareholder for accurate projection of the

intended capital budgeting decisions which in return deters the financing process and serially

impacts the profit-making process. Mathuva (2015) notes that where the market is based on

absolute speculation of the price patterns and trends, the capital budgeting decisions can be

arrayed to the public for intents and purposes directed to attract more investors onboard.

Importantly, the managerial staff should incorporate all the information available in an efficient

market when they embark on capital budgeting tools. This will facilitate synchronized

fundamental analysis that corresponds to the shareholders anticipated wealth and profit

maximization.

MARKET EFFECIENCY 6

References

Brigham, E. F., & Houston, J. F. (2012). Fundamentals of financial management. Cengage Learning.

Kida, T.E., Moreno, K.K. and Smith, J.F., 2001. The Influence of Affect on Managers' Capital‐

Budgeting Decisions. Contemporary Accounting Research.

Mathuva, D. (2015). The Influence of working capital management components on corporate

profitability.

McWilliams, A., Siegel, D.S. and Wright, P.M., 2006. Corporate social responsibility: Strategic

implications. Journal of management studies.

Yalçın, K. C. (2010). Market rationality: Efficient market hypothesis versus market anomalies.

European Journal of Economic and Political Studies.

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