I have never really put much though
into the issue of paying dividends, simply because I have believed it to be
pretty straightforward process. An investor buys shares in a company and in
return they receive a large pay out (dividends), simple yes? Regrettably not, after
this weeks lecture I have once again had my eyes opened to the complex and
arduous task companies face when dealing with issues of paying dividends.
Research carried out suggest that
investors use dividend signals to assess a companies performance, and that
stock returns are positively correlated by dividend fluctuations (Asquith &
Mullins 1983 and Aharony & Swary 1980). Having said that it seems to me too
presumption to assume that a change in a company’s dividend level means that there
has been a change in performance or profitability?
I accept that in certain scenarios
a decrease in dividends may lead to a lack of investor confidence, and that
investors would argue that dividends are preferable to capital gains because of
the fear of uncertainty. However this can be due to a miss-guided feeling that
their future investment may get tied up in uncertain projects. Unfortunately we
do not live in a ‘perfect world’, and managers are in possession of sensitive
operational information that is not always made accessible to investors for
fear company investment plans are made public knowledge. Whilst I understand
that a degree of secrecy is needed, I do believe that there needs to be a bit
of ‘give and take’ on both sides. Whilst investors do get to find out such
information in annual reports, as they make a beeline to the page that is most
concerning for them, I can’t help but think that there is a lack of trust
between the two camps.
One reason for retaining residual
income is to reinvest in future investments, investments that in the long-term
will create higher returns and maximisation shareholder wealth. However if such
projects are not fully communicated to shareholders carefully they can have an
adverse affect. Due to this lack of insider information all investors can do is
look to dividend levels to access company performance, with the basic
assumption being: high dividend = good
low dividend = bad
However as discussed above, it’s
not all black and which and in reality the reverse many be true:
high dividend
= lack of good investments and thus lower future investment returns.
low dividend = indication of attractive
investments made and future prospects.
It could be argued that investors
are too short sighted and that managers jeopardise potential long-term profit
gains in favour of high dividend returns. Which in return contradicts the
concept of shareholder maximisation when it is in fact the very same people who
are preventing companies from doing so. It makes me think of the saying ‘all
good things come to those who wait’ and questions whether there can ever be a
happy medium. In order for companies to give high dividends they need to have
made good investments in the first place. I do feel that in this case investors
seem to hold the higher ground and can leverage their options to move their
stocks to another company where higher dividends are being paid.
One way of dealing with this is for
companies to offer a steady dividend return, that way they can attract the
right ‘clientele’ to their company. In order for this to work however the
dividend policy needs to remain constant, changes would drive the clientele
away to companies that were better able to fulfil their needs, and destroy shareholder
value. This lack of fluctuation with the dividend level would reduce the
problem of communicating with shareholders and give clarification to
shareholders that the company was progressing rather than sending them into a
fear of uncertainty.
However the view presented by Miller and Modigliani (1961), suggested that the value of the company was
created and secured through investment decisions and not dividend decisions. Therefore
rationally shareholders wouldn’t care if their return on investment was made
through capital gains or dividends and rejects the ‘bird in the hand’ argument
that dividends offer certainty rather than uncertainty of capital gains.
What is clear is there doesn’t
seem to be a right or wrong dividend policy. It seems to be a very situational
opinion and one that is very dependent on each individual company and the needs
and expectations of shareholders. I do believe a constant level seems to offer
a sense of certainty but we do not live in certain times and companies don’t operate
in certain markets, therefore I think fluctuations are both unavoidable and
part and parcel of the securing investor finance and investing in future
long-term opportunities.