Problem
a) Treasurer Josh Frydenberg has criticized large Australian corporations for returning their cash earnings to shareholders via dividends and share buybacks. He said that instead "corporate Australia must help lift flagging productivity, and hence wages, by investing in their businesses" (AFR, Aug 26, 2019). Evaluate this statement from the point of view of economic theory. How should a ?rm decide whether to reinvest its earnings or return the pro?t to shareholders?
b) Consider the following statement; "Over the long-run, risk and return within equity markets are not related. Selecting stocks with a higher risk (i.e. higher standard deviation of the return), does not necessarin guarantee a higher return. This fact contradicts investment theory, which states that higher risk should give a higher expected return." Do you agree with this statement? Critically evaluate it in light of the lessons we learn in class.