Dividends by definition are a distribution of a segment of a company’s earnings that are issued to shareholders who hold a stock on the record date. The decision to release dividends to shareholders can only be taken and vetted by the board of directors This record date differs from the well-known ex-dividend date which is the first date after the declaration of a dividend that the buyer of a stock is not entitled to receive the next dividend. Due to the high level of volume with which many stocks are traded, the ex-dividend date is usually two days prior to the record date to allow for considerable processing undertaken by stock exchanges. The issuance of dividends is a considerable decision taken in line with other capital deployment priorities and allocation alternatives such as buybacks or acquisitions. Of late dividend policy has received a lot interest from investors and executive boards as a result of the circumstances that many companies now find themselves in the aftermath of the global recession that broke in 2008. With an environment that encourages executives to examine their dividend policy it is no wonder that there has been a recent resurgence of dividend increases and initial issues in 2011, while S&P dividends still remain only at 80% of what they were pre-crisis.
There are numerous factors that play a role in driving dividend policy in today’s financial environment. One must remember that a great deal has changed as regards the health of corporate balance sheets, capital markets, investment opportunities and investor demands. Corporations across the globe have been striving to shore up their own cash or cash equivalent positions since the onset of the financial crisis. The result?, record amounts of cash are now held on company balance sheets, in a manner not seen since the 1950s. Nowhere is this highlighted more than in the United States where an estimated one trillion dollars of cash or cash equivalents was held as early as the first quarter of this year. Excess liquidity could potentially be used to distribute dividends to shareholders, many of whom bore the brunt of poor equity returns in recent years.
With the good health of corporate balance sheets and historically low treasury rates, debt yields have been relatively low in 2010 and less so in 2011. As result companies have been taking advantage of these favourable rates to refinance their existing debt and explore the possibility of funding new investment opportunities. Indeed those companies that have the added bonus of a strong credit rating have almost unlimited access to credit markets, thus adding another dimension of liquidity and in turn flexibility. This flexibility opens the door to numerous investment opportunities that could act as a comparative advantage over competitors with less manoeuvrability at this point in time. Abbott Laboratories(ABT:NYSE) epitomizes a company that took such a brave and proactive approach to capital distribution. In 2010 Abbott spent approximately 8.5 billion dollars on inorganic growth, including the acquisition of Piramal Healthcare, making Abbott the largest pharmaceutical company in India. It was hoped that the acquisition would act as a base from which to grow the company’s emerging market business. Modest GDP growth in developing nations has forced companies such as Abbott to look further afield for acquisition opportunities, a tactic that has not always proved successful in the past due to large corporations failing to grasp the realities of foreign operating environments etc. Also of note are the changing demands of investors, when faced with economic uncertainty, are becoming more risk averse and are looking to the likes of dividend aristocrats for steady, consistent yields. A company that can provide over 25 consecutive years of dividends speak volumes about its capital discipline and fortitude.
There has been considerable empirical studies conducted over the years on Dividend policy which strove to identify the primary factors that influenced the setting of dividends from the perspective of management. Lintner from his piece in the 1956 American Economic Review argued that firms only have four distinct concerns when it came to setting dividends. Firstly every firm had a target dividend pay-out ratio that it sought to meet in the long term. Initial dividends would often be set to a low pay-out ratio in a growing company to facilitate capital flexibility and relatively high in a mature company that had consistent revenue streams. Secondly changes in the dividend would only reflect changes in the long-term revenues of the firm, thus embedding a sustainable dividend policy. Thirdly management are highly concerned with the perceived impact and reaction of investors when changes occurs to the pay-out ratio. A reduction in dividend is often perceived by investors as an indication of lessened future revenues and managements negative outlook. Also of note is the fact that a reduction has a more lasting impression than an increase of a dividend from an investor viewpoint (Lang and Litzenburger 1989).Lastly once management decide to set a dividend they do so with the intention of it remaining intact for the foreseeable future, out of fear of how a reversal may be taken by the markets. This framework was given added backing from (Fama and Babiak 1968) who rigorously applied it in numerous test and found it to be relatively consistent with decision making processes observed by mainstream management.
Predictably investors like consistency and this is where a sustainable dividend becomes highly attractive, whereby a firm’s dividend regularly increases and shows little indication of a decrease. Investors can usually determine if firm’s dividend is sustainable based on cash-flow analysis such as discounted cash flows. The transparency of dividend policy and strong longer-term value implications means that the decision making process must be calculated and well executed. By ring-fencing future cash flows for use as dividends firms can display capital discipline by only utilising excess cash flows for other uses such as the maintenance of debt, buybacks or simply added liquidity.
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