Saturday, December 27, 2008

Sticky dividends!

When we look at how companies have set dividends in most markets, the word that comes to mind is "sticky". Put another way, most companies set absolute dividends and stick with those dividends through good times and bad. A few even have a policy of consistently raising dividends and continue to do so, even in the worst of times. This has been true for decades in the United States, but I was curious about whether the last three months of market turmoil have made significant inroads into changing the policy. The answer seems to be yes, but with caveats...

1. S & P keeps track of how many companies in the S&P 500 index increase, decrease and suspend dividends, by month. In the last quarter of 2008, 32 firms increased dividends, 17 firms cut dividends and 10 suspended dividends. No firm initiated dividends during the period. If you are surprised that more firms increased dividends than cut or suspended dividends, here are the statistics for the previous three quarters.
  • First quarter, 2008: 93 increases, 7 decreases, 4 suspensions
  • Second quarter, 2008: 65 increases, 9 decreases, no suspensions
  • Third quarter, 2008: 45 increases, 6 decreases, 8 suspensions
  • Just as a further contrast, in all of 2007, there were 299 dividend increases, 7 decreases and 3 suspensions.
2. Some companies did deviate from long-standing dividend behavior in these last three months. To provide an illustration, Pfizer did not increase its dividends in 2008, for the first time in 42 years, evoking an article in the Wall Street journal wondering why they decided to do so...

I think 2009 will lead to even more conservative behavior, at least when it comes to dividend policy. After all, one reason that companies felt comfortable maintaining dividend payments, even in the face of declining earnings or losses, was the belief that they could raise funds from capital markets, if they needed them. If the last quarter of 2008 has taught them a lesson, it is that capital markets can shut down even for the largest companies in the most developed markets. There is a new found respect for large cash balances at companies, though I am not sure how long it will last.


Mahesh Sethuraman said...

Dear Prof,

I have a doubt here. Even assuming that companies were able to raise money in capital markets, does it make sense for companies to stick to the same level of dividends when their profitability is at a huge risk? Isn't that inefficient i.e, value reducing to the shareholder as the cost of serving the capital which is not utilised for improving productivity is again borne by the shareholder?

Ofcourse the huge risk of profitability is a retrospective judgment but isn't it a possibility that management should have take into account while deciding on dividends?

A more abstract question - why should companies declare dividends at all in an efficient market? Like we argue for diversification and even for hedging, if investors are better, then it should be left to them right? So investors can always create homemade dividends right?

Aswath Damodaran said...

You seem to be making a round-about argument for the irrelevance of dividends. Dividends are irrelevant only if
a. Tax laws treat dividend and price appreciation equivalently.
b. The presence of cash balances in companies does not alter their investment policy
Neither assumption holds up. Hence, dividends matter for better (sometimes) and worse (others).

Unknown said...

In the particular case of Pfizer, another reason likely is that they have a lot of their $26b cash hoard in low tax jurisdictions and repatriating that cash would have tax consequences. That coupled with them not wanting to raise cash via debt in this market probably led to this decision. Merck also made a move similar to Pfizer's...while Eli Lily, Abbott etc continued their streak of increasing dividends.

Unknown said...

Hello Prof. I am a great fan of yours. and I am an MBA student from India.

I have a question relating to your article. Just curiosity though.

Do you think in the scenario where Stock indice are falling, companies would be interested to initiate Public offers? IPOs?

Do you think public would be having enough faith on the companies demanding for capital?


Aswath Damodaran said...

IPOs go up and down with the market cycle, peaking when markets are up and dropping when markets are down. In fact, there were no IPOs for 12 weeks from the end of August 2008 to the end of November 2008 in the US, the longest such stretch since 1980.

Unknown said...


Have you taken a look at the high yield and distressed market lately? Some companies with tangible assets and pretty good brands have debt trading very very low, while the equity goes up. Seems to make little sense to me unless liquidity premium is going up....

Aswath Damodaran said...

There are a lot of bargains available to investors in almost every market (equity, preferred stock, bonds and even real estate) but with two caveats:
1. You need the liquidity to stay with your investment for the long term.
2. You have to believe that this is just a global recession, albeit a strong one, and that we will bounce back to historic norms, once the recession is over.
The market right now is building in a significant likelihood of a catastrophic recession (or a depression, if you prefer that term)... Time should tell.. But if you wait for time to tell, it will be too late.

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