Dividends seen as mark of virility rather than lack of business nous

Reinvesting profit rather than paying dividends is the way to shareholder wealth, says business editor JIM EAGLES in the second of a three-part series.

Why do New Zealand companies pay out virtually all their profits in dividends instead of using the money to grow?

Joseph Healy, of the ANZ Bank, suggests in a forthcoming book that, in New Zealand, "Dividends have come to be such a mark of corporate virility [that] managers have felt under pressure to maintain them even when cash is short ... Dividends are paid [even] when as a result companies have to go back to the capital markets to raise more debt or equity ... "

Perhaps the best example of this is the high dividend policy followed by the former Brierley Investments, highly popular with shareholders in the golden years, but a severe embarrassment in tougher times.

This was highlighted in the 1998 chairman's report when, in explaining the company's problems, Sir Roger Douglas noted that, "Rather than adopting a policy aimed at maximising shareholder returns, the board attempted to comfort shareholders via a 9 cents per share dividend. Not only was this policy damaging to BIL's balance sheet, because the dividend could not be serviced from free cashflow, it was also inefficient because only 3 of the 9 cents carried imputation credits."

Another classic demonstration came in March last year when - as it was heading into disaster - Air New Zealand announced a 9 cent unimputed dividend to shareholders following a rights issue. Chairman Sir Selwyn Cushing explained that the payout was "for loyal shareholders who have come to expect a dividend".

As Mr Healy comments caustically, "Of course what loyal shareholders really want is to see the value of their investment grow. Those that need cash can sell some shares."

But there is another side to the argument. Both logic and economic theory suggest that what companies deliver is what the markets want.



A New Zealand example came during Fletcher Challenge's heyday when it tried to implement a US-style low-dividend, high-growth policy. The shareholders hated it and the company was forced to recant. FCL's subsequent lack of growth in spite of its spending spree rather suggests that in that case the shareholders were right.

Bryce Wilkinson, director of Wellington-based Capital Economics, comments on the FCL example, "The point is that you have to invest the money you've retained wisely, or the investor reaction is likely to be that they'd rather have the money as a dividend, thank you very much."

But while companies have a responsibility to use shareholder funds wisely, it does seem extraordinary that most New Zealand companies are evidently unable to identify any new ventures worth investing in.

In the US, for a company to admit it had no better use for its profits than to give them back to shareholders would be seen as management incompetence.

John Redmayne, of PricewaterhouseCoopers, describes the different attitude of New Zealand companies as "a puzzle".

"It seems to have just become conventional wisdom: directors seem to feel that that have to pay out a big dividend - the same as last year - or they'll be hammered.

"Unfortunately that belief also seems to be borne out by experience. For instance, when Telecom announced they were reducing their payout from 90 per cent of profits to 50 per cent, for reasons which seemed to me entirely convincing, their share price got clobbered."

An ANZ Bank booklet, aimed at convincing New Zealand companies to rethink their dividend policies, argues that the key to changing such attitudes is good corporate communications strategy.

"If properly presented to investors and the market, a cut in dividend can send a positive signal. A company would, however, have to convince the market that it has opportunities for making value-enhancing investments, and that it is using the cash saved to exploit those opportunities."

But Dr Graeme Camp, a lecturer in accounting and finance at Auckland University's business school, believes there are other factors behind the high-dividend phenomenon: the tax imputation system and the level of market-risk premium used in calculating the viability of new projects.

Regarding the market risk premium, Dr Camp maintains that the level required in New Zealand - at present generally regarded as 8-9 per cent - is far too high.

"The rates of return needed to cover that make it very hard to come up with projects which look viable. The result is that a proposal that would be considered uneconomic in New Zealand may well be seen as attractive in the US."

On the tax question, Dr Camp says New Zealand's tax imputation rules provide little incentive to retain profits. But, he argues, directors exacerbate that by assuming that if a company has imputation credits it must ensure they are used by paying dividends.

Certainly, he says, a dividend with imputation credits attached means shareholders do not pay the full personal tax impost. But "wealth typically results from the firm making sound investments in new projects rather than from attempting to beat the tax system".

* Part three, tomorrow, looks at the economic impact of the high dividend policy.