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Dividend cut? Why not eliminate it?
 

golfer4life's picture
ER
(Monkey, 47
 
Points)
 on 4/14/08 at 3:32pm

Just want to here some thoughts on why a financial firm should still pay a dividend on its common stock if they are facing a liquidity crisis and need raise capital? Wachovia will reduce their dividend to .375 from .64. Why not stop paying a dividend and reduce dilution with all of these convertible capital infusions?
Am I missing something?

4damoney's picture

shareholder

CF
(Baboon, 130
 
Points)
 on 4/14/08 at 3:52pm

sharholder confidence..as funney as that sounds with the current situation. They are trying to show that although they are pulling in funds for their balance sheet, they still have the financial stability to provide shareholders with income.

If they cut the div totally out...shareholders would start to bail!

smuguy97's picture

In theory, dividends create

PE
(King Kong, 1,004
 
Points)
 on 4/14/08 at 7:35pm

In theory, dividends create not only a larger tax bill, but also a more immediate one (e.g., 35% taxes on dividends in each year as opposed to a single 15% capital gains tax in 10 years).

In practice, however, dividends are used as a mechanism for positive signaling between a firm and its equity investors. Firms that pay dividends have greater exposure to the capital markets (e.g., since earnings cannot simply be "stockpiled" internally if explicit dividend payments must be met). In addition, paying out dividends reduces the amount of free cash flow that may be squandered by firm managers (although leverage would do this in a more tax efficient manner).

There is also a general belief that dividend payments are fundamentally more secure than retained earnings, although this doesn't hold much water given that most dividends are simply reinvested into the original equity.

jdm05520's picture

Dividends have actually

PE
(Chimp, 13
 
Points)
 on 4/14/08 at 9:13pm

Dividends have actually received favorable tax treatement since 2003 (taxed at 15% for most taxpayers). However, 2008 is the last tax year for which this law applies.

Along with positive signaling, reducing, rather than eliminating a dividend prevents certain institutional investors with a mandate to invest in dividend paying stocks from being forced to sell large blocks of shares.

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