Dividend policy is a firm’s policy with regards to paying out earnings
as dividend versus retaining them for reinvestment in the firm. It is the division of profit between payments
to shareholders and reinvestment in the firm (Hussainey, Oscar
Mgbame & Chijoke‐Mgbame,
2011).
Dividends act as ‘conveyors’ of information about the
company. An unexpected change in
dividend is a good indication of how the directors view the future prospects of
the company (Arnold, 2013). For example
Lloyds bank recently announced that it will resume paying dividends to
shareholders, after it reported full-year statutory profits of £1.8bn. Lloyds had not paid dividends to shareholders
since the 2008 financial crisis (BBC News, 2015). Lloyd’s shareholders could interpret this
decision to pay dividends as meaning Lloyds bank directors are optimistic about
the future of the bank, having recovered significantly from the financial
crisis. When this information on
dividend payments was released, the share price rose by 0.6%. This can be interpreted as confirming the
theory set out in my 2nd Blog which talked about Stock Market
Efficiency where shares rationally reflect all available information.
However as Arnold (2013) states, it is risky for managers
to increase the dividend above the regular growth pattern if they are not
expecting improved business prospects.
An example of this could be WM Morrison PLC where the company has
increased dividends for the past 5 years (see figure 1), despite the company
having a very poor year for fiscal year ending 2014 (see figure 2). It is reasonable to suggest that Morrison’s
shareholders may have been misled by the company’s directors as increasing its
dividend may have given shareholders the impression that the company is
performing well, despite its struggles performing against the ‘discounters,’
namely Aldi and Lidl. However in saying
this, Morrisons had been committed to a dividend payment policy of a certain
level for the past number of years, the final dividend of which is due to be
paid this year.
Opposition to paying dividends came from Miller and
Modigliani (MM Theory) in 1961 who stated in their academic paper that dividend
policy is irrelevant to shareholder wealth. One of the main arguments they advanced was
that firms are able to finance projects which have a positive NPV from retained
earnings or by issuing new shares at the same cost which would have otherwise
have been paid out to shareholders in the form of dividends (Arnold, 2013). An example of the MM Theory in practice is
the recent case of Vodafone. On the 6th
March 2015, Vodafone’s share price fell dramatically to a 2 month low,
following speculation of a dividend cut.
Analysts at Nomura, the financial services group, cited reasons such as
necessary acquisitions which were draining Vodafone’s free cash flow (Elder, 2015). This supports the MM
Theory as Vodafone have been investing in projects (taking on acquisitions),
most likely with a positive NPV and therefore have chosen to cut dividends in
order to fund these worthwhile investments.
I think Miller and Modigliani’s theory that dividend policy
is irrelevant is difficult to support.
Although, arguably, they have reason to suggest that cash should be
retained to be invested in positive NPV projects, I believe that this can be
applied to only one of many different investor classes or ‘clientele’ as
referred to by Arnold (2013). Other investor
classes may want a high and stable dividend yield immediately and therefore do
not want to wait for a dividend which is declared years down the line as a result
of investment by the company in positive NPV Projects.
Arnold, G. (2013). Corporate financial management. Harlow,
England: Financial Times/Prentice Hall.
BBC News,. (2015). Lloyds to resume dividend payments.
Retrieved 8 March 2015, from http://www.bbc.co.uk/news/business-31655343
Hussainey, K., Oscar Mgbame, C., & Chijoke‐Mgbame, A.
(2011). Dividend policy and share price volatility: UK evidence. The Journal
Of Risk Finance, 12(1), 57-68. doi:10.1108/15265941111100076
Elder,
B. (2015). Vodafone stumbles on dividend payout fears. The Financial Times.
Retrieved from
http://www.ft.com/cms/s/0/d71f85b0-c423-11e4-9019-00144feab7de.html#axzz3TibguTE2
Markets.ft.com,. (2015). WM Morrison Supermarkets PLC, MRW:LSE financials - FT.com. Retrieved 8 March 2015, from http://markets.ft.com/research/Markets/Tearsheets/Financials?s=MRW:LSE
Interesting viewpoint on how Morrisons dividend policy mislead shareholders into having a positive outlook on future prospects
ReplyDeleteThank you for your comment Ben. Yes, I think Morrisons are trying to keep their shareholders on side as they are seeing their market share increasingly reduced as they face intense competition from the discounters such as Aldi and Lidl. This can only be expected to continue in the future.
DeleteThis comment has been removed by the author.
ReplyDeleteIt would be interesting to see if Morrison's have any dominant shareholders which may have influenced their decision to pay out a high dividends to meet the needs of this shareholder. It would appear to me that perhaps Morrison's are trying to attract a certain clientele as mentioned. In general, i think they are trying to send a message to their shareholders to say "don't panic". I have written a similar blog with regards to Standard Chartered's dividend policy, be sure to give it a read as it is fairly similar to Morrision's situation.
ReplyDeletePrivate shareholders have 86% holdings in the firm which may explain why Morrisons committed to a dividend payment policy because this type of clientele may want dividend payments every year and do not see their investment as a long-term one. I read your blog about Standard Chartered and I see similarities between this firm and Morrisons, despite these firms being in completely unrelated industries. Both these firms seem to make promises to shareholders to try and make amends for their poor performance. Do you think these companies can fulfil these promises in the next few years or do you that think these are false promises made by management to retain their shareholders?
ReplyDeleteFor me personally, the answer actually lies within your blog post, you mentioned that Arnold (2013) states, it is risky for managers to increase the dividend above the regular growth pattern if they are not expecting improved business prospects. This would suggest that both Morrisons and Standard Chartered expect better profits in the future, but at the same time, nothing is ever guaranteed in the business world. If it turns out that profits for these companies continue to fall, these large institutional shareholders will be very disappointed. Whether they can afford to make such huge losses and sell their shares is very much debatable. What are your views on this matter?
DeleteI think this year will be a make or break year for both companies. If the companies implement successful strategies which can improve business performance, there is no reason why they can not turn this around. For example, Morrisons have taken on the discounters in terms of slashing prices. Although in saying this, I completely agree with you that there are no guarantees in the business world.
Delete