The marshmallow test is one of the most well-known child psychology studies. Designed to test delayed gratification, each child is left in a room with one marshmallow and promised a second if they manage to resist the temptation to eat the first while they wait.  

How would you have done on the test as a child?  How would you do as an adult?  And if we replaced marshmallows with dividend payments, would you be a patient investor and accept less cash now on the promise of better long-term returns?    

Corporations reward shareholders for investing in their companies by distributing a portion of their profits back to them as dividends and every year the financial markets eagerly await payout announcements. A number of big names are expected to make dividend payments in April (you can view some of them here). No doubt they will attract public criticism, but they are also considered a sign of how well a company is performing.   

Though they often attract bad press, the reality is that paying dividends to investors is an essential part of the way the economy works. Without investors’ cash the global economy would grind to a halt.  The more capital a business has, the more opportunity it has to grow, become profitable, create jobs and generate wealth. We need our companies to have healthy dividend yield rates to attract investors.  The problem starts when those yield rates are not an accurate reflection of how well a company is doing, and are even incentivising the kind of short-term wealth-extraction behaviour which damages a company’s performance and overall stability in the long-term.

Image courtesy of Canva

Dividend excess puts companies at greater risk of collapse  ​

Over the past 30 years companies have been paying more and more to shareholders in the form of dividends and stock buybacks and often even loading up on debt to do so. Take Carillion whose high profile collapse in January 2018 cost taxpayers an estimated £150m and the loss of thousands of jobs.  Between 2009 to 2016 it paid out three quarters of all the cash it made from its operations in dividends.  Even worse, in the five years before 2018 it paid out £63million more in dividends than it generated in cash.  Or Thomas Cook who despite a turbulent few years and a tumble in profits only stopped dividend payments ten months before its collapse in January 2020.   
These companies aren’t alone. According to a recent Financial Times article ‘more than a quarter of the UK’s biggest listed companies and a third of large US public businesses spent more on dividends and buybacks in 2019 than they generated in net income.’  The article cites a study from the University of Sheffield, Queen Mary University of London and Copenhagen Business School which says that “Pre-pandemic excesses”, where management focused on maximising short-term shareholder payouts, have “hollowed out” company reserves and left many businesses struggling to cope with the fallout of the coronavirus pandemic.

Dividend payment strategies like these and other activities which maximise the financial health of a business on paper (like withholding payments to suppliers in the final months of the financial year in order to make their cash position look better) are the antithesis of good corporate governance. Companies that continue to pay out dividends despite making a loss might do so to reassure shareholders and stabilise their share price, but the reality is that it creates a financial house of cards which can undermine the foundations of our economies and put the long-term viability of even our seemingly most stable corporations at risk.  

Bouncing back better? 

One of the many knock-on impacts of the pandemic was that UK investors saw a 38% reduction in their dividends in 2020. Payments were cut, suspended or even cancelled as companies held onto their cash reserves to ride out the crisis. As with many things COVID-19 has given us a narrow window of opportunity to do things differently but with businesses recovering and announcing their 2021 results it seems as though most companies wish to resort to business as usual. By January 2021 FTSE 100 companies had already declared dividends of £1.1billion and restored £91million of distributions.    

Take debt-laden security firm Convergint Technologies who, despite struggling with cashflow when COVID hit in March 2020, raised a further $1.4bn in loans to refinance its debt and fund a $600m dividend to its owner Ares just 12 months later in March 2021. This has left the business with a debt burden that is nine times bigger than its earnings and reduced its operating cash flow to around 5% of its total debt, compared with 15% before. The short-term financial benefits to Ares of such a strategy are obvious but so is the longer-term risk to the financial stability of Convergint Technologies and the security of the jobs of the thousands of people who work for them. Ares’ investors should be asking questions.     

It is estimated that it will be 2025 before dividend payments return to their 2017/18/19 high but before we revert to our old ways there is an opportunity for both companies and their investors to rethink their dividend payment strategies. Taking a more sustainable approach to dividend payments minimises risk and offers the opportunity to reap far greater long term rewards for investors. 

Long term versus short term value creation  

Grow the Pie advocates for stakeholders as partners rather than rivals Image Copyright Alex Edmans

The issue with dividend payments isn’t whether they should be made, nor how much they are, it’s about whether a company has considered where else its profits could be used by to grow the value of the business for all its stakeholders before paying out dividends. 

This is what Alex Edmans, Professor of Finance at London Business School calls ‘Growing the Pie’.  In his seminal 2020 book he describes a company’s social value as a pie from which all its stakeholders - investors, staff, customers, communities, suppliers - receive a slice. A traditional business approach views the pie as fixed in size; all stakeholders are rivals and the only way to increase one member’s share is to reduce the size of another’s.  In this reality, increasing shareholders dividends directly reduces the size of the slice available for employees' wages, for example.   

Edmans suggests a more successful 21st century business model would be to view the pie as expandable and adopt a pie growing mentality which benefits investors and stakeholders alike.  Edmans calls this pie growing behaviour ‘Pieconomics.’   

Take Royal Mail for example.  After many years of poor results they experienced a boost for their parcel delivery business caused by the surge in online shopping brought about by Covid. At the end of this bumper year they immediately announced a large dividend payment to shareholders.  Unfortunately their UK business is suffering from years of underinvestment and it is not clear whether the increase in business is a temporary or long term thing.   

CEOs who are committed to increasing the value and size of their pie increase the size of the returns for all their stakeholders, not just their shareholders. Instead of demanding dividend payouts now, Royal Mail’s investors should be demanding the money is reinvested in the business to deliver a responsible, long-term growth-focused strategy. It doesn’t matter how many millions you pay out in dividends in this scenario, because everyone wins.   Businesses grow wealth for shareholders at the same time as growing value for everyone else.  In other words, by waiting, investors will get two pieces of marshmallow instead one.   

Certainly Larry Fink, the hugely influential chairman and CEO of BlackRock thinks there’s a clear relationship between business leaders who grow the pie and longer term rewards for investors. In his influential annual letter to investors in January 2021, he explained: “The more your company can show its purpose in delivering value to its customers, its employees, and its communities, the better able you will be to compete and deliver long-term, durable profits for shareholders.”

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Larry Fink, Blackrock

What does a ‘sustainable dividends payment strategy’ look like?  ​

Businesses who have a surplus of cash at year end usually use it either for share buy-backs, which boost earnings per share, or payment of dividends.  But what if instead of taking this short-term pie splitting view, they reinvested the cash into growing their pie and creating long term value for all their stakeholders? Over time, the rewards for investors would be greater.  One fifth of £500 million is worth a lot more than half of £100 million.    
How you grow the pie depends on your business and who your stakeholders are but some ideas for pie-growing things business leaders could consider before paying everything out in dividends would include:  

• Increase the salaries of their lowest paid workers or offer them share incentives
• Reduce their standard payment terms and commit to paying their suppliers in 30 or even 14 days – read our article here for more on this
• Pay off debt and invest in their cash reserves (and at the same time lobby policy makers to do something about the tax inefficiencies that discourage companies from having large cash reserves) Invest in reducing the deficit of your pension scheme 
• Invest in new products/environmental efficiencies  read our article here about this   
• Make quality more important than price and include social value in their procurement criteria.  Read more on social value in procurement here
• Pay their fair share of tax read more on this here 
• Pay back Government handouts  

 A good example of a business with a sustainable dividend payment strategy is Tesco who, in January 2021, announced a further £5bn special dividend payout to shareholders.  Having already reduced their financial debt they have no further need for large amounts of cash but are only returning cash to investors after they’ve paid £2.5bn into their pension scheme, eliminating the need for additional contributions which will improve operating profit in future years.   

Contrast Tesco’s behaviour with that of developer Lendlease, who made 15% of their UK workforce redundant in October 2020 and then two months later announced they were paying investors dividends of £57m. Lendlease could have kept every single one of the 240 members of staff it made redundant last year employed on a salary of £40,000 each, and still paid out a dividend to investors of £47.4m.    

We know who we’d rather invest in, buy from (and work for).

Where does the responsibility lie? 

ESG is the quantifiable measuring of a company’s impact and behaviour by monitoring the Environmental, Social and Governance (ESG) metrics that matter to investors. ESG criteria are increasingly being used by analysts to help them avoid companies whose practices could signal a risk factor.  But Dividend Payment Strategies do not currently appear in the eight specific criteria that S&P Global use  to rate Governance part of ESG assessments.  
  
Companies can either do this voluntarily or deal with the legislation that will follow.  In March 2021  the UK government announced plans to stop large businesses paying out dividends and bonuses if they can’t afford them and to encourage Directors to focus on the long-term success of the company  
 
While we wait for legislation to catch-up and a global standard for sustainable investment funds to be put in place, where does the responsibility lie?   Should companies take the lead and reduce dividend payments to more sustainable levels with long-term goals in mind?  Or is it unrealistic to think that companies will do this unless investors that purport to be interested in ESG stop chasing the highest short-term yield and show their commitment to a more sustainable future?  Is it actually the responsibility of investors to take the lead; to engage more and to use their power and influence to hold businesses to account and drive change forward?   
 
Some companies are making changes. Earlier this year, GlaxosmithKline announced a “new-look Glaxo [that] can have a meaningful global impact on health and achieve significant value creation for shareholders.” As part of this change, the company announced it will be introducing a new dividend policy in 2022. It hasn’t given details but has told shareholders that rates will be ‘lower than at present’ - the company has since seen the value of its shares fall – at least in the short-term.   Meanwhile, BP and Shell have also both announced they are permanently scaling back their dividend payments to use funds to invest in renewable energy although in their case their business model faces an existential threat to its existence and increased legislative pressure.   
  
At Samtaler we help corporations take the opportunity to change how they operate and to find ways of putting social as well as economic value at the heart of how they do business. By doing so we make them better than their competitors.  
 
Our businesses are the lifeblood of our economy; we need them, we need their investors, and they need to pay dividends but only if they can do it in a way which prioritises long term shareholder value over short-term stakeholder value.  Anything else is just killing the goose which lays the golden egg.  

Title Photo by Tyler Milligan on Unsplash

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