Why Push for Dividends?
Hi all,
I'm struggling to understand the motive behind what appears to be a pretty common shareholder request to "improve shareholder value":
- Assume there's a firm with $100 in total value, 50% held by debt and 50% by equity.
- Say the firm issues a total dividend of $25 from excess assets
I understand that equity value will go down by the $25 accordingly. This means that the issuance of dividends to clear off $25 in excess assets neither created nor destroyed shareholder value.
My question is, given this, why do shareholders (e.g. activist funds) so often push for dividends, claiming that they "improve shareholder value"? Assuming excess assets are invested at 0 NPV by the firm (e.g. they often buy Treasuries), there appears to be no difference between holding them versus distributing them as dividends.
Is this just a disconnect between academic vs reality? e.g. could it just be a personal preference of shareholders wanting their money back sooner to invest in alternatives, or some kind of expression of shareholder-orientation by management that may consequently raise stock prices?
If it’s being invested in treasuries that’s usually negative NPV since cost of capital is higher than the interest
Thanks for your reply. Are you sure this is true? My professor noted that this would be 0 NPV as the yield earned in this case equals the discount rate considering it's a risk free investment, so risk free yield = risk free discount rate. Normally best theoretical practice for valuing firms separate excess assets from operations so your discount rate (WACC for operations) is different between the two.
Sorry, I don’t understand this point and am genuinely curious. The company doesn’t raise some special cheap pocket of capital to invest in these treasuries. It’s the same capital and same cost that is being used for operations. Hence, why would it have its own WACC?
Shareholders expect a higher rate of return than the risk free rate. If a company invests cash at the risk free rate, that is a negative NPV investment for the shareholder because they expect a higher level of return
The shareholders don't trust the management to select projects that would create value so instead they would rather get the cash in dividends and invest it themselves in other companies (as you mentioned).
Additionally, stocks with a high dividend yield may warrant a slight premium from retail investors provided the dividend is sustainable and not funded with debt (see Icahn short). So I guess that could "unlock value" in the share price, even if it goes against the theory that the stock price should decrease by the amount of divided per share since assets are decreasing.
Pushing for dividends, when one can push for stock buybacks, is dumb in almost every single circumstance. Besides capital gains tax rates being less than ordinary income tax rates, there is also the question of realization. There are many reasons why one would want to push off realizing the return. But dividends says fuck off with that. Dividends are also much stickier. They effectively add a fixed cost. That isn’t exactly great for shareholders.
The only time this isn't the case is if the stock buyback materially changes the ownership. A great example of this is how back in the 80s Getty Oil was 40% owned by the Getty Trust. Another example is if a bank has a 9% shareholder.
Thanks for your thoughts. I’m also thinking the following: Buybacks are better pushed considering if they are made at a discount to intrinsic value, this is essentially a positive NPV investment in the firm itself whereas dividends (assuming 0 NPV excess assets) don’t “improve value”. Would this be correct?
That is also a fair understanding.
I would also add to my previous comment that dividends may be appropriate for regulatory reasons (or something like this). For example, Cap Fed would issue these massive dividends to stay under the $10b threshold. They simply needed to get assets out the door and in relatively big numbers. If they did share buybacks they’d have no shareholders in like a decade or two
Agree with the others and would just add I think you're falsely equating "shareholder value" with "equity value" which is causing your confusion. Your IRR can be improved despite having the same NPV due to timing of the cash flows.
How much would you pay for a company that has 100M$ of cash on its balance sheet, but zero expectation of ever paying a dividend or buying back shares?
The value the company eventually needs to be returned to shareholders or else it’s not really worth anything. That’s why company with bad capital allocation who are not returning money to shareholders can trade at a heavy discount. (See Japanese equities)
Asperiores ad vero dolorem et laudantium explicabo non. Suscipit earum reprehenderit numquam occaecati. Aut sint dolorem voluptatum nobis deleniti atque.
Quasi tenetur quis quam enim non qui error. Nulla in labore qui temporibus odit. Eos delectus cupiditate et exercitationem temporibus nam alias. Cupiditate rerum delectus recusandae voluptas repellendus vero.
Eum voluptas omnis incidunt adipisci et sit veritatis. Quo ut commodi fugit nihil enim fuga autem fugiat. Dolor fugiat explicabo aperiam maiores eos molestias consequatur. Iusto magni nihil in dolor nobis. Ut sit nemo ad vitae vel. Eos sit architecto non ut explicabo necessitatibus exercitationem. Asperiores occaecati aliquid alias ex dolor illum voluptas vel.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...