Cutting dividends is one challenge, restarting them is another
Amid the huge collapse in share prices over recent weeks, one trend has stood out. Public companies have reduced the dividends they pay at a record pace. In the past 30 days, more than 40 per cent of companies listed on the main London market have suspended their dividends. This vastly exceeds the pace in the aftermath of the 2008 global financial crisis and has put at risk annual payments worth more than £50 billion. Companies across the spectrum of the economy are preserving cash on their balance sheets, rather than returning it to their owners, given the scale of economic uncertainty ahead. While many policymakers have welcomed this prudence — indeed, financial regulators have all but insisted on it for banks and insurance companies — this is not without significant ramifications. Like all Covid-19 decisions, there is set to be a painful sting in the tail.
It is easy to caricature dividends as like bonuses paid to super-wealthy owners. Certainly, payments such as the £1.2 billion paid by the Arcadia Group to Lady Green in 2005, or the £60 million paid last month by Easyjet to Sir Stelios Haji-Ioannou, help to reinforce this image. As with many anecdotes that generate headlines, they are a poor representation of the whole picture.
Scratch below the surface and there is a range of Britons directly affected by the decision to scrap dividends. For the 70 per cent of workers saving into a workplace pension, dividends are part of the accruals that they are putting aside for later life. For the 70 per cent of workers saving into a workplace pension, dividends are part of the accruals that they are putting aside for later life. For many retirees, dividend payments are part of the income that they rely on to pay the rent and buy basic goods and services.
Many retirees have looked at the modest income on offer from an annuity — a guaranteed income insurance policy — and have chosen to seek out greater returns by owning shares in reliable dividend-paying companies. Over the past decade, as these annuity rates have headed lower, cash individual savings accounts — Isas— have offered pitiful returns and as pension freedoms have enabled greater flexibility, savers have sought higher returns wherever they can be found.
Now, many readers of the Times may shrug and say that this collapse in dividend payments is the price that savers must pay for taking on greater risk. After all, capitalism is dead if risk and reward do not go hand-in-hand. However, as we have seen with Covid-19 support for workers, businesses and charities, this “moral hazard” argument rightly goes out of the window when an economy is in an enforced shutdown. Particularly one that nobody foresaw. Indeed, in the United States, the central bank has just announced plans to buy non-investment-grade debt in some of America’s riskiest companies, helping to fuel a further rebound in the US stock market. The world’s most powerful financial institution effectively has jettisoned the idea that risk is a factor in determining who to support, and who not to.
Much as the Treasury is coming under pressure to support workers and the self-employed not covered by recently announced schemes, it should expect an increasingly large postbag from disgruntled savers that feel robbed of their dividend income. Only time will tell if the government can resist this pressure.
Looking beyond the immediate crisis, the economy will reopen, business cashflows will turn positive and, over time, economic activity will return to normal. No economist can tell when this will be, despite some confident forecasts to the contrary. Our profession needs to be more comfortable with saying what it doesn’t know, particularly when the scientific expertise — on which this hinges — has not yet established a viable exit strategy. However, when the economy does reopen, a key issue facing companies that have cut their dividends recently is at what point they restart these payments. There are three factors to consider.
First, what approach will regulators and politicians take to limiting dividend payments? It will be politically popular to curtail dividends by companies that have accessed taxpayer support. Depending on the economic damage wrought by the Covid-19 crisis, this may prove to be a persistently popular message. Twelve years on from the global financial crisis, public anger surrounding banks remains a lightning rod for curtailing their behaviour. There is a clear risk that this sentiment will extend to a far wider group of companies in the aftermath of coronavirus.
Second, a lot of the support being accessed by companies is in the form of debt, with question marks over how this debt will be treated in future. Restarting payments to shareholders while having a significant liability to debt-holders may prove controversial. It is unclear which providers of capital will be prioritised. If it is to be debt-holders, then shareholders may decide that they are prepared only to pay a lower price for owning shares in listed companies. Over time, this will increase the cost of equity for growth companies, with significant ramifications for productivity and expansion.
Third, this pause in dividend payments inevitably will create the space for company directors to consider whether paying dividends represents the best use of shareholder capital. One possible explanation of Britain’s poor productivity in recent years has been the inclination of company boards of some of our largest companies simply to recycle profits back to shareholders in the form of dividends, rather than invest in research and development and the productivity of their workers. One potential upside of dividends being frowned upon is a diversion of company profits towards more growth-generative activities.
The reality is that the teeth of an economic crisis is a poor time to make long-lasting decisions. There are too many short-term issues to focus on. Yet in every boardroom, government department and regulatory office, there will be small teams thinking about what comes next. When it comes to determining the future for how company profits are distributed, it will be wise to put the extraordinary events, and emotions, of this period to one side. Capitalism does not survive and thrive on soundbites.
A version of this piece was published in The Times.