What’s the most important task for the CEO of a quoted company? Driving earnings per share forwards, perhaps? Increasing the rate of return on capital employed? Taking notice of a wider community of ‘stakeholders’?
A generation ago, the answer to that question would have been a lot simpler. His or her main duty was to maintain (or even better, steadily increase) the amount the firm paid out to its shareholders every year. And yet, over the last decade, the dividend has gradually dwindled in importance, until it often appears to be little more than an easily expendable luxury. That is a big mistake.
Research published this week by Capita Registers showed just how far dividends have fallen down the list of the City’s priorities. In total, UK listed companies paid out £56.9bn to their shareholders in 2009, a reduction of around £10bn, or 15%, on 2008. Much of that was accounted for by some of the big banks scrapping their dividends as a result of the credit crunch. But it was far more widespread than just the financial sector. Overall, 202 listed firms cut their dividends, and of those, 74 paid out nothing at all. Meanwhile, 179 firms increased their payouts, while 60 held them steady.
The situation is even worse if you look at the balance of payments between companies and investors. Taking the last two years together, quoted companies paid out £123bn in dividends. But they took back £124bn in rights issues to bolster their balance sheets (about 60% of which went to the state-rescued banks). Investors were net losers from the deal. Nor is that likely to get any better soon. In the coming year, Capita only forecasts a 5% rise in the overall levels of payouts.
It is all a far cry from the days when the dividend was king. When BP cut its dividend in 1992, during the slump in the oil market and a global recession, it was such a traumatic event for the oil giant that it was thought necessary for the whole board to be restructured. Tycoons such as Tiny Rowland could build whole careers on the simple rock of constantly paying out high dividends to armies of small shareholders.
These days, CEOs appear to think they can push the dividend up or down a bit, according to market conditions. It doesn’t seem to be any more important than adjusting the advertising budget. It certainly isn’t something that would prompt the resignation of the board. Nor would it raise much more than a few grumbles among the shareholders.
There are some reasons why dividends have declined in importance. They aren’t, for example, always tax-efficient – investors have to pay income tax on them, compared to usually lower capital gains taxes on increases in the share price. So companies have explored other ways of rewarding shareholders, such as share buy-backs. Fine, but dividends are still vital for three reasons.
First, they are a crucial component of shareholders’ total return. Over the medium-term, the owners of capital will be rewarded just as much by payouts as they will by any rise in equity markets. More importantly, companies can control dividends. There isn’t much they can do about share prices.
Secondly, dividends can’t be fiddled. A clever finance director can come up with all sorts of different ways of measuring performance, most of which can be tweaked depending on where you park different assets and liabilities. Investment bankers can also devise fiendishly complex ways of restructuring companies that are meant to ‘create value’ for shareholders. Such value may or may not be real. But a policy of paying out 50p per share every six months is simple to understand and completely transparent.
Thirdly, the dividend is the essence of what a stockmarket is about. Investors give companies their money to build factories, shops and warehouses. In return, they receive a steady share of the profits in the form of dividends. Lose sight of that, and it is hard to think what the stockmarket is really for. So what can the markets do about dwindling dividends? Two changes would help.
First, why not link the pay of chief executives directly to the dividend? Replace baffling remuneration schemes with a slice of the total pay-out to shareholders. If they can get the dividend up, then they make a lot of money. If they cut the pay-out, they lose a lot of money. It would be simple, easy to measure, and would align their motives with their shareholders’ motives.
Second, institutional shareholders should get back to the policy of turning on boards that chop the dividend. Reductions should be a last resort, not an easy cost target during a downturn. Make it clear that the chairman and chief executive are expected to offer their resignation at the same time as they make any cut.
Both measures would very quickly make paying out regular and rising dividends the main priority of most listed companies. Fairly quickly, that would make for a far healthier stockmarket and one that is a lot more rewarding for investors.