Dividend policy: who wins, who decides?

Dividend policy is a very complex subject. The first thing to clarify, however, is the difference between dividends, profit margins, the result of all sells…

Dividends are a portion of a company’s earnings, which distribution is decided by the board of directors. The board also decides which class of shareholder is to be given dividends. Most of the time, dividends are distributed as a certain amount by share. The dividends are what is left after the company had paid non-operational, operational, non-financial and financial debts and taxes. Therefore, a company can have a high turn-over, and yet not enough to be able to distribute dividends to its shareholders.

 

“Dividend policy” is a concept that concerns numbers of firms. Indeed, when a company makes some profit, the managers have to decide how to use those profits. They then have the choice between two different orientations. They either keep the dividends in the company, to invest on new projects for example, or, distribute them to the company’s shareholders.

If the company decides to distribute the dividends, a “dividend policy” may be established. But who decide what policy will be bet for the company? To whom does it benefit most? As a management decision, the managers are supposed to decide how to allocate the dividends they earned for the company. However, the dividend allocation policy will have an impact not only on the company management, but also on how other investors may see the company from the outside, in the financial markets. Unfortunately, managers can sometimes be influenced by important shareholders. 

As I said earlier, there are two different policies. If managers decide to keep dividends inside the company instead of giving them away to shareholders, they will be able to increase the company’s capital and therefore create shareholder value. On the other hand, by giving away the dividend to its shareholders, the company will eventually increase its capital by attracting other investors. In both situations, shareholder wealth is maximised. However, shareholder may not agree with one or the other of these policies. Indeed, like in several countries, the “revenue of” capital and the cash received as dividends by shareholder don’t have the same tax rate. But then, who should choose which policy to apply? Would it be fair to everybody? Most probably not. Therefore, I believe that the only possible solution is to compromise.

 

Indeed, we can take the example of two companies with very different dividend policies. Amazon chose not to distribute any of its dividends during its first year. Managers preferred to wait that the company become stable enough. Not distributing dividend during the first year allowed amazon to develop with equanimity.

 

On the opposite side, we can take the example of Woolworths. During the last years before it closed, it distributed almost all its profits to shareholder as dividends. However, by doing this, the company got poorer and actually destroyed shareholder value. In part because if this dividend policy, the company closed in 2009, making redundant about 27 000 employees.

In conclusion, I think that the dividend policy is a very complex policy but of major importance for a company. It is up to managers to decide how to allocate the dividends, but they must try to be fair to every stakeholder in the company. I don’t think that not giving dividend to shareholders is a solution, and it wouldn’t be fair to them. But on the other side, giving them too much, like what happen in Woolworths, is not an option either (it was certainly not fait for the 27 000 employees who lost their jobs!). I really think that the solution lie in finding a compromise that would work for all stakeholders. But what do you think? Is it better to distribute all dividends? None?...