The last thing companies should be doing right now is paying dividends

Font Size:

Andrew Linden, RMIT University and Warren Staples, RMIT University

The economic heart attack induced by COVID-19 has revealed an ugly truth – many very large companies have too little cash to ride out sharp downturns.

Cash flow variability, and the inability to retain earnings to buffer that variability, is one of the most common reasons small businesses fail.

Because large companies have raised large amounts of cash through public offers, and take in large amounts of cash in their ordinary operations, they ought to be more resilient.

Yet even though the pandemic-inspired shutdowns are mere weeks old, many big companies such as Virgin Australia and listed childcare providers are already pleading for or receiving public guarantees and bailouts.

Other companies such as Flight Centre and Cochlear are rushing to raise extra funds though discounted share placements.

Bond and debt markets are experiencing severe problems, making it difficult for these companies to borrow.

Why are big companies so vulnerable?
Catastrophic declines in cash flow are only half the story.

The other half is the three-decade focus on maximising shareholder returns.

Companies have used four strategies to keep their share prices high and push them higher.

First, they have paid out profits to shareholders in the form of dividends, leaving them with less to build cash buffers, pay higher wages and reinvest in the business.

Reserve Bank research shows that over the past three decades dividend payouts have trended up over time to more than 80 cents of every dollar of corporate profits.

In some companies dividends payouts exceed 100 per cent of profits.


Read more: Australia’s appetite for dividends could cannibalise economic growth


Second, the same Reserve Bank research points to the increased use of share buybacks and dividend reinvestment plans. The former boosts share prices by shrinking the stock of shares. The latter boosts demand for that stock.

Third, to lock in these historically high dividend payout ratios, shareholders, including institutional shareholders such as superannuation funds, have demanded boards agree to dividend guarantees.

In Australia, these demands for higher and higher dividends have been partly driven by dividend imputation, which attaches a ‘refund’ of company tax to dividend payments, making them even more valuable to mum and dad investors, and also to super funds, which have a heavy bias to equities.

Fourth, executives have been induced to make sure share prices climb higher and higher by remuneration packages that provide bonuses linked to high share prices.


Read more: Words that matter. What’s a franking credit? What’s dividend imputation? And what’s ‘retiree tax’?


Finally, companies have had to borrow heavily to cover ever increasing dividend payments and buybacks.

As Edward Altman, father of the Altman Z-score for predicting bankruptcy, observes, the vast majority of US companies are now B rated (just above junk). Thirty years ago many were A rated.

Increased borrowing is making it hard for many companies to borrow more money or to issue bonds except at junk-grade interest rates.

The COVID-19 crisis has exposed the flaws of sucking liquidity out of companies to maximise shareholder returns as did the global financial crisis before it.

Directors need to consider their legal duties
Directors have a legal obligation not to trade while insolvent. Not having enough cash on hand to pay bills as and when they fall due triggers this obligation.

APRA letter to financial institutions, April 7, 2020

In times of crisis, where the solvency of corporations is a live question, preferencing shareholders over creditors and employees by paying dividends or buying back shares or borrowing to pay dividends is likely to be a breach of duties because it sucks even more liquidity out of the business and increases leverage.

Both the Bank of England and New Zealand’s Reserve Bank have stopped their banks paying dividends.

On Tuesday, Australia’s Prudential Regulation Authority took the unusual step of writing to banks asking them to be extremely cautious about paying dividends.

The Australian Shareholders’ Association has urged the government not to go further and issue a formal direction to banks to suspend dividend payments, saying shareholders rely on dividends to “cover their living expenses”.

Things can’t return to how they were before
When the pandemic is over and the economy recovers it will become clear that the pre-crisis rates of shareholder returns were not sustainable.

Until then, the public might be being asked to pick up the tab to save needlessly febrile companies, just as it has picked up a different sort of tab as a result of systemic misconduct in banking justified by need to keep shareholder returns high.

Post-crisis, companies should be made to wind back returns to shareholders in order to build adequate buffers, invest in their businesses and pay their workers more.The Conversation

Andrew Linden, Sessional Lecturer, PhD (Management) Candidate, School of Management, RMIT University and Warren Staples, Senior Lecturer in Management, RMIT University

This article is republished from The Conversation under a Creative Commons licence. Read the original article.

How will you cope if dividends are shelved?

If you enjoy our content, don’t keep it to yourself. Share our free eNews with your friends and encourage them to sign up.

Join YourLifeChoices today
and get this free eBook!

Join
By joining YourLifeChoices you consent that you have read and agree to our Terms & Conditions and Privacy Policy

RELATED LINKS

The case for dividends if interest rates remain low

While retirees tend to prefer ‘safe options' for their nest eggs, higher yields through dividends

Seven things for investors to keep in mind during the crisis

AMP's chief economist provides some tips for thinking about your money and what to do with it.

Could franking credits and dividends be used to fund stimulus?

The PM says ‘no', but could franking credits and dividends still be seen as options?

Written by The Conversation

21 Comments

Total Comments: 21
  1. 0
    0

    Companies should continue to pay dividends as that money belongs to their shareholders. If they need money then they should raise it instead of scraping dividends. It’s like a bank not paying interest because they want to keep their cash.

  2. 0
    0

    Qantas has deferred paying their dividends from April to the 1st September.

  3. 0
    0

    Companies can call on shareholders to contribute funds in the event the company needs additional funding. Suspending payment of dividends is a sound proposition at this time as it may prevent such a call being made.

    • 0
      0

      The issue with that is that our insane pension system in Australia pretty much forces those who saved for retirement to rely on dividends to fund their living expenses. If dividends cease, the government may have to rethink the aged pension system, otherwise hundreds of thousands of SFRs will be starving, or having to sell out their assets at a huge loss and join the ranks of pensioners permanently, which would be very bad for the economy.

  4. 0
    0

    Companies can call on shareholders to contribute funds in the event the company needs additional funding. Suspending payment of dividends is a sound proposition at this time as it may prevent such a call being made.

    • 0
      0

      Easy for pensioners to say. Clearly you have no idea about he realities of life for many retirees who need dividends to live on and certainly don’t have the capacity to provide additional funds to the companies they invest in.

  5. 0
    0

    Perhaps their CEO’s were just plain greedy. Some salaries were obscene for the little work they do. no one was worth that amount of money.

  6. 0
    0

    The method by which various Governments over the past 20 years has been to encourage people, as they become of retirement age, to endeavour to be self sufficient (self-funded) – as much as is possible.
    Many have done this – however the one caveat has been – we rely on the bigger end of town, including banks, to share their profits back to shareholders in the way of dividends.
    Older people are an easy knock down target when it comes to “changing the rules”.
    In my case – if banks defer or suspend dividends past this year to zero – we will be unable to live. We will have (just) too much in assets to attain any kind of Gov Pension and health benefits – so we will need to sell assets to live.
    This Government will need to be very mindful of what happened to Shorten – even if the playing field has moved a little.

    • 0
      0

      You are right many self funded retirees rely on these dividends to live. This is particularly necessary with near zero interest rates as well.

      Not paying dividends means more on the age pension sooner rather than later.

      Companies should pay dividends ae normal and raise capital if they need it the same as they did during the GFC. That way those who can afford it contribute but those who rely on their dividends get them to.

    • 0
      0

      You can add Super Funds as well, I don’t know how Super Funds can Handle Both Lack of Dividends as Well as Early Payments of $10k to Members/Holders.
      The situation could get out of Hand Very Quickly by not Paying or Reducing Dividends.

  7. 0
    0

    The method by which various Governments over the past 20 years has been to encourage people, as they become of retirement age, to endeavour to be self sufficient (self-funded) – as much as is possible.
    Many have done this – however the one caveat has been – we rely on the bigger end of town, including banks, to share their profits back to shareholders in the way of dividends.
    Older people are an easy knock down target when it comes to “changing the rules”.
    In my case – if banks defer or suspend dividends past this year to zero – we will be unable to live. We will have (just) too much in assets to attain any kind of Gov Pension and health benefits – so we will need to sell assets to live.
    This Government will need to be very mindful of what happened to Shorten – even if the playing field has moved a little.

  8. 0
    0

    The key takeaway – Heavy borrowings to pay increasing dividends, leads to lower cash buffers and re investment in the business. Obscene salaries for the Executives and low wages for workers was always unsustainable. Better to cut back on dividends and keep the business viable. It was obvious with all the publicity surrounding refund of Franking Credits, that too many people were over exposed to Australian Shares.

    • 0
      0

      A viable alternative for self-funded retirees would be helpful. Managed funds invest in shares. Interest is too low to be of any use. Direct real estate creates some major issues. There just aren’t a lot of choices for retirees who are denied a pension. What are they supposed to live on?

  9. 0
    0

    The article starts of with some valuable comments about why some dividends are higher than wisdom would suggest.Then it goes off on a tangent critising dividend imputation and suggesting its valuable to mum and dad investors.Somehow that’s a bad thing.In the end the authors bias is clear by his comment that companies should use their profits to pay workers more.This virus sadly seems to be a reason for wanabe communists to spread their disease.

  10. 0
    0

    The article starts of with some valuable comments about why some dividends are higher than wisdom would suggest.Then it goes off on a tangent critising dividend imputation and suggesting its valuable to mum and dad investors.Somehow that’s a bad thing.In the end the authors bias is clear by his comment that companies should use their profits to pay workers more.This virus sadly seems to be a reason for wanabe communists to spread their disease.

Load More Comments

FACEBOOK COMMENTS



SPONSORED LINKS

continue reading

Health news

How age influences gender-related outcomes after heart attack

Age is an important factor in who experiences a heart attack, but there are significant differences between men and women....

Internet

Web inventor says news media bargaining code could break the internet

Tama Leaver, Curtin University The inventor of the World Wide Web, Tim Berners-Lee, has raised concerns that Australia's proposed News...

Lifestyle

Surprising things you probably didn't know about beards

Whether you're a razor-dodger yourself or a pogonophile (a person who loves beards), you'll agree, a lustrous covering of facial...

Social Networking

The appalling role models influencing younger generations

I know I am not in the demographic to be affected by the influencers of the world. I am too...

Finance News

We've stockpiled more than $200 billion of extra savings

The federal government says the economy won't "fall off a cliff" when it scraps COVID-19 income support measures because Australian...

News

Cricket Australia stands firm on 'Australia Day' decision

Cricket Australia (CA) is standing its ground in not referring to January 26 as "Australia Day" as part of its...

Finance

What the new consumer law changes mean for your rights

Australia's consumer rights and protections are set for a major shake-up from 1 July this year and it means that...

Entertainment

Friday Funnies: Star signs

Whether you believe that your heart and mind are mapped out in the stars or not, you'll have a chuckle...

LOADING MORE ARTICLE...