top of page
Search

Do companies really need to cut/omit their dividends?

Writer's picture: mezianelasfermezianelasfer

Updated: Apr 14, 2020

Should listed companies spend lots of time thinking as to whether to maintain/increase or to omit/cut their dividends? In normal circumstances, yes, because they know their past performance and they can forecast their future. In general, those that increase or maintain their dividends performed well in the past and have good future prospects, while those that cut/omit their dividends did badly in the past, but since dividend is a strategic decision and considered highly by the board, it is taken as the last cost cutting/cash conserving strategy, as their future performance is relatively stable. In this context, the recent arguments of the CEO of Tesco that the increase in dividend reflected performance in the year to the end of February is half-baked, as this should signal also future prospects, which may not be that rosy.

However, with Covid-19, we are living in different times. In addition to the traditional motives of dividend payments, such as signalling, catering for the needs of shareholders, particularly pension funds, mitigation of agency conflicts, cash retention, especially for financially weak companies and those chiefly affected by the pandemic, it is claimed that well-capitalized businesses are scrapping the payouts for fear of public backlash if they are seen to be rewarding shareholders. These arguments are contradictory as while some point to paying dividends, others suggest that firms should scrap them.

There are some solutions to these controversies. The first and foremost is to assess whether the firm can carry on with no revenue, and, therefore making losses, for the next, say, six months, until, hopefully this pandemic is over, but they have enough distributable reserves to pay as dividends, These strong firms are expected to carry on paying dividends, even if they recur to their debt financing, as was the case of Shell, and reduce their Capex, as was the case with many oil companies in the past. These firms, especially if owned by pension funds, can even see their managers take a pay cut, to show their commitment and keep the loyalty of their shareholders.

An alternative will be to offer dividends in the form of shares rather than cash. These so-called scrip dividends have been used by many companies in the past. The company creates new shares equivalent to the cash dividends. The dividend is maintained and cash is conserved for firms to weather any future uncertainty created by Covid-19, while shareholders can sell them in the market if they need cash.

Another possibility is to transfer the “social responsibility blame” of paying dividends to shareholders. In this context, firms could state that their dividends are cumulative and they offer option to shareholders to either opt to receive their dividends today of to postpone it to next year, and receive inflation adjusted dividend of this year and next year. Investors who are in need of funding, such as some pension funds will opt to receive their dividends this year, while patient and more understanding investors will postpone them.

Both these strategies can be adopted by healthy companies, while weak ones would have no choice than to cut/omit their dividends. In case the Covid-19 crisis persists for more than the six months assumed above, then even those good companies will become weak and, at that time, dividend cuts/omissions will become the norm. However, while scrip dividends may be resented by managers as they imply issuance of new shares that may affect future earnings and dividend per shares, the second option is likely to be preferred but by only companies who expect good prospects. In this case, investors will be able to distinguish between good and bad companies and firms will stop worrying about this issue and focus on managing their assets to create value in these difficult times.


14 views0 comments

Recent Posts

See All

Stock market delisting

The announcement by DP World today of its delisting from NASDAQ Dubai (https://www.ft.com/content/bf96d684-5161-11ea-8841-482eed0038b1 or...

Comentarios


  • LinkedIn Social Icon

© 2019 Meziane Lasfer

bottom of page