In my Money Week column this week, I've been arguing that shareholders shouod be pushing for higher dividends. Here's a taster....
What’s the most important task for the chief executive of a quoted company?
Driving earnings per share forwards, perhaps? Increasing the rate of return on capital employed? Or taking notice of a wider community of ‘stakeholders’.
A generation ago, the answer to that question would have been a lot simpler. His or her main duty was to maintain, and even better steadily increase, the amount that the company paid out to its shareholders every year.
And yet, over the last decade, the dividend has gradually dwindled in importance, until it often appears like little more than an easily expendable luxury.
That is a big mistake. Dividends are a crucial component of the total returns investors can make on their money. And they are a great way of disciplining chief executives. If there is one thing the City should try and get right in the next decade it should be getting dividends back onto the pedestal they once occupied.
Research published this week by Capita Registers showed just how far dividends have fallen down the list of the City’s priorities. In total, UK listed companies paid out £56.9 billion to their shareholders in 2009, a reduction of around £10 billion, or 15%, on 2008. Much of that was accounted for by some of the big banks scrapping their dividends as a result of the credit crunch. But it was far more wide spread than just the financial sector. Overall, 202 listed firms cut their dividends, and of those, 74 paid out nothing at all. Meanwhile, 179 companies increased their payouts, whilst 60 held them steady.
The situation is even worse if you look at the balance of payments between companies and investors. Taking the last two years together, quoted companies paid out £123 billion in dividends. But they took back £124 billion in rights issues to bolster their balance sheets (about 60% of which went to the state-rescued banks). Investors were net losers from the deal. Nor is that likely to get any better soon. In the coming year, Capita only forecasts a 5% rise in the overall levels of payouts.
Much the same is true in the US. Thirty years ago, according to Standard & Poor’s figures, 94% of American listed companies sent a cheque every quarter to shareholders. Now it is only 74%.
It is all a far cry from the days when the dividend was king.
When BP cut its dividend in 1992, during the slump in the oil market and a global recession, it was such a traumatic event for the oil giant that it was thought necessary for the whole board to be restructured. Tycoons such as Tiny Rowland could build whole careers on the simple rock of constantly paying out high dividends to armies of small shareholders.
These days chief executives appear to think they can push the dividend up or down a bit, according to market conditions. It doesn’t appear to be any more important than adjusting the advertising budget. It certainly isn’t something that would prompt the resignation of the board. Nor would it raise much more than a few grumbles among the shareholders.
There are, of course, reasons that dividends have declined in importance. They aren’t always tax-efficient – investors have to pay income tax on them, compared to usually lower capital gains taxes on increases in the share price. Companies have explored other ways of rewarding shareholders, such as share buy-backs.
But it has gone too far.
Dividends are important for three reasons.
First, they are a crucial component of shareholders’ total return. Over the medium-term, the owners of capital will be rewarded just as much by the payouts on their shares as they will be any rise in equity markets. More importantly, companies can control it. There isn’t much they can do about share prices. Equity markets are buffeted by dozens of different events. But they can always decide their dividend.
Next, it an’t be fiddled. A clever finance director can come up with all sorts of different ways of measuring performance, most of which can be tweaked depending on where you park different assets and liabilities. Investment bankers can devise fiendishly complex ways of restructuring companies that are meant to ‘create value’ for shareholders. They may or may not be real. But if a company used to pay out 50p per share every six months, it either still does or it doesn’t. It’s completely transparent.
Thirdly, the dividend is the essence of what a stock market is about. Investors gives companies their money to build factories, shops and warehouses, In return, they receive a steady share of the profits in the form of dividends. Lose sight of that, and it hard to think what the stock market is really for.
So what can the markets do about it.
Two changes would help.
First, why not link the pay of chief executives directly to the dividend? Instead of baffling schemes designed to pay-out if they hit a whole series of benchmarks, just offer them a slice of the total pay-out to shareholders. If they can get the dividend up, then they’ll make a lot of money. If they cut the pay-out, they’d loose a lot of money. It would be simple, easy to measure, and make sure they were motivated by precisely the same target as their shareholders.
Next, exert some discipline.
Institutional shareholders should get back to the policy of turning on boards that cut the dividend. It should be a last resort, to be used only an the direst of emergencies, not one of the first costs that can be sliced during a downturn. Make it clear that the chairman and chief executive are expected to offer their resignation at the same time.
Both would very quickly make paying out regular and rising dividends the main priority of most listed companies again.
And, fairly quickly, that would make for a far healthier stock market – and certainly one that was a lot more rewarding for investors.