Dividends: a bad corporate strategy?

[Milton]

I just came across this 2007 blog comment on a Harvard Business Review article: Harvard’s Breakthrough Idea: Don’t Pay Dividends! ::: Capital Flow Watch.

Unfortunately, I can't access the original HBR article (not without paying a $6.50 fee, anyway). But reportedly it advocated the stupid "breakthrough idea" that, when faced with excess cash, management should waste the money on an acquiition strategy, notwithstanding inflated prices.

I am not so naïve as to think that this sort of warped corporate thinking doesn't secretly happen all the time. But it's rather shocking to see it publicly lauded by the Harvard Business School.

[cute fuzzy bunny]

I havent read their article either, but every credible piece I've read up until now demonstrated quite clearly that corporate management is about as efficient at spending excess cash as the federal government is.

I'll take the dividends, please...

[Texas Proud]

Here is the problem... and probably why Harvard said what it said...

Shareholders 'give' you thier money for YOU (the corporation) to invest for them....

If you give them money back (dividend)... it is like saying 'I can not make more than you can with this money'....

NOW, tell me how many people with big egos will say that

[RunningBum]

Originally Posted by Texas Proud

Here is the problem... and probably why Harvard said what it said...

Shareholders 'give' you thier money for YOU (the corporation) to invest for them....

If you give them money back (dividend)... it is like saying 'I can not make more than you can with this money'....

NOW, tell me how many people with big egos will say that

I don't think that's an accurate analogy because you're usually not buying the shares directly from the company.

[cute fuzzy bunny]

Originally Posted by Texas Proud

NOW, tell me how many people with big egos will say that

Not many. I got front row seats to watch my old corporate management invest in lots of little company's they shouldnt have, buy company's we couldnt fit into our structure, dive into market segments we didnt know how to compete in, and do cool stuff like embed computers in surfboards.

I like to see companies make money on their core business, reinvest in sensible capital assets where required, and then when they run out of ideas for what to do with the cash...give it back to the investors.

[Texas Proud]

Originally Posted by RunningBum

I don't think that's an accurate analogy because you're usually not buying the shares directly from the company.

The original sale gave the corp the money....

They still have the money...

They can either 'invest' or 'dividend'.... they are doing it for the current shareholders....

So... my analogy is correct... it does not matter who you bought the shares from...

[chinaco]

I would prefer the dividend form about 75% of the companies as opposed to management investing in so called new growth opportunities. Especially in larger companies. Let's face it... most senior management in large companies are incompetent in that area.

The growth mainly comes from smaller companies... larger ones are just typically trying to hand on to what they have acquired (defend their position). If they develop a new opportunity, it is to feed the existing behemoth with cash.

[clifp]

Not paying dividends is great if you are a corporate executive with a very small stock position in the company you are running. Especially you have a monster compensation package, which is completely dependent on higher stock. In that case you probably want to save your cash in order to do stock buyback or even better a a new acquisition.

Then next year when you talk to the compensation committee you can see I no longer run a $2 billion corp, I run a $3 billion company pay me more. Plus with those extra interest payments on the loans we took out we don't have to worry about having so much cash that we are a take over target.

Somewhat seriously if you are Warren Buffett you can get way with no dividends, likewise if you are a startup or even a rapidly growing company like Google or Ebay, no dividends might make sense.

For everybody else, I am own a piece of the company, show me the money!

[free4now]

What clif said.

The whole idea of owning stock (unless you are a speculator) is to get a piece of the company's profits. Except for companies in their growth phase (which I'm not very interested in), they should be earning a profit and returning that profit. If companies just build share price until the day they go bankrupt, never paying a dividend, the shareholder never gets a dime back on their investment. The question any long term shareholder should ask is not IF they will pay a dividend but WHEN.

Even Buffett really should start paying dividends now that they are not so bad taxwise.

[Milton]

Originally Posted by clifp

Then next year when you talk to the compensation committee you can see I no longer run a $2 billion corp, I run a $3 billion company pay me more.

Exactly right.

[RunningBum]

Originally Posted by Texas Proud

The original sale gave the corp the money....

They still have the money...

They can either 'invest' or 'dividend'.... they are doing it for the current shareholders....

So... my analogy is correct... it does not matter who you bought the shares from...

When the company is in it's growth stage and issues shares to raise capital, it does not make sense to give dividends for the reason you say, and almost none do.

Years later, the company may be as big as the market allows, and acquisitions may not fit well. What makes the most sense then is often running the business efficiently to make profits and return some of that in the form of dividends.

[Abreutime]

Originally Posted by free4now

What clif said.

The whole idea of owning stock (unless you are a speculator) is to get a piece of the company's profits. Except for companies in their growth phase (which I'm not very interested in), they should be earning a profit and returning that profit. If companies just build share price until the day they go bankrupt, never paying a dividend, the shareholder never gets a dime back on their investment. The question any long term shareholder should ask is not IF they will pay a dividend but WHEN.

Even Buffett really should start paying dividends now that they are not so bad taxwise.

Due to the structure of American tax laws, where capital gains are taxed at lower rates than the high marginal income rates, it's in the best interest of most shareholders to not have income from dividends. Companies are trying to act in the best interest of shareholders when they choose to buy-back stock, which boosts the stock price by reducing the number of shares outstanding (as well as simply sending a signal to markets that the company is doing well). Eventually, mature firms need to start paying out the profits to the shareholders. However, I'm quite happy with them buying back my shares in the meantime.

[RunningBum]

Originally Posted by Abreutime

Due to the structure of American tax laws, where capital gains are taxed at lower rates than the high marginal income rates, it's in the best interest of most shareholders to not have income from dividends.

Won't these be qualified dividends (assuming the stock is held more than 61 days), which aren't taxed at the marginal rate, but instead the same rate that LT cap gains are taxed?

[cute fuzzy bunny]

Yes...except for unusual circumstances dividends are qualified and taxed at the same rate as LT gains, not at ordinary income rates.

[M Paquette]

Originally Posted by cute fuzzy bunny

Yes...except for unusual circumstances dividends are qualified and taxed at the same rate as LT gains, not at ordinary income rates.

This year...

The "Jobs and Growth Tax Relief Reconciliation Act of 2003" cut in dividend tax rate to the long term capital gains rate sunsets at the end of this year. In 2009 we go back to the old rates.

[RunningBum]

Originally Posted by M Paquette

This year...

The "Jobs and Growth Tax Relief Reconciliation Act of 2003" cut in dividend tax rate to the long term capital gains rate sunsets at the end of this year. In 2009 we go back to the old rates.

It's been extended to 2011 with the Tax Increase Prevention and Reconciliation Act of 2006 (TIPRA).

[SecondCor521]

This is an interesting reprise of part of my MBA finance class.

Paying dividends restrains corporate management in two ways -- they can't waste the money on lousy investments, and it may restrain any "cash flow risky" investments because they have to make sure the dividend gets paid.

Another thing that mgmt sometimes considers is whether a dividend has been paid for a while. If so, the company may have attracted a shareholder clientele which wants to be paid dividends and would get peeved if it were cut or eliminated.

There is also interesting interplays between dividends and share price. If a company changes dividend policy that can get interpreted by Wall Street to mean different things. Adding a dividend, for example, may lead the Street to think that the company's growth rate will be slowing.

I'd have to dig out my notes for the rest of it, but it's a complicated subject.

2Cor521

[M Paquette]

Originally Posted by RunningBum

It's been extended to 2011 with the Tax Increase Prevention and Reconciliation Act of 2006 (TIPRA).

Oops. My bad.

I'm sure there will be something else along in the next few years. Makes it hard for a corporation to set a long term policy (Capital appreciation vs dividends).

Good thing none of us have to do any long range financial planning with possible tax impact, huh?

[mathjak107]

anyone ever figure out what say MO philip morris would have been worth per share if they didnt keep siphoning off company assets as dividends every year?

[cute fuzzy bunny]

Maybe a lot less, since many of their investors bought the stock for the dividend. Otherwise, who would want to buy into a company that gets its pants sued off every other year and who is constantly under assault by federal/state/local regulations and the entire medical industry?