The Case Against Dividends

Commentary about business and finance.
Dec. 17 2013 7:29 AM

Dividends Are Evil

They’re a triumph of short-term thinking and do nothing for the economy.

GE Profile™ Series 30" Slide-In Electric Range stove, left, and GE(R) 30" Free-Standing Electric Range stove.
If you buy one of these stoves, GE gets your money. If you buy GE stocks, GE gets nothing.

Product shot courtesy GE

Last Friday two venerable American corporate brands, General Electric and AT&T, both raised their dividends in response to good business news. Next month, GE shareholders can expect $0.22 per share, up 16 percent from its previous quarterly dividend of $0.19. AT&T’s move was a more modest 2.2 percent increase. But while GE is partially rolling back dividend cuts implemented at the depth of the recession, AT&T is on a steadily increasing path, with last week’s move marking the 30th straight year of dividend hikes.

The only problem is that dividends are terrible. Bad for the economy, bad for business, and surprisingly unfavorable to investors. A barbarous relic of a less financially sophisticated era, they’re also indelibly coated with misleading rhetoric that perpetuates sloppy thinking about business, profits, and investment.

“Returning value to our shareholders is one of AT&T’s top priorities,” said the company’s CEO, Randall Stephenson, announcing the dividend hike. Ed Crooks at the Financial Times likewise referred to GE’s move as “part of a plan to return more capital to investors.” Apple spokesman Steve Dowling used similar rhetoric in response to Carl Icahn’s awful push for share buybacks.  “Earlier this year we more than doubled our capital return program to $100 billion,” Dowling told Time, referring to an April dividend increase.

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Under the circumstances, it’s worth being very clear: When firms pay dividends, nobody is returning anyone’s money. It is true that at some point in the distant past these firms raised money in an initial public offering, and that some companies even actually do use IPO money to finance growth and investment—although recent high-profile IPOs, such as Facebook’s and Twitter’s, are really more about letting early employees cash out and get rich. But General Electric was a founding member of the Dow Jones industrial average back in 1896. Anyone whose equity investment in GE helped build the firm died a long time ago. Shareholders in large, publicly traded firms got their stock by buying it from other shareholders. That’s the whole point of becoming a publicly listed firm—so your shares can trade in a deep and liquid market.

In other words, if you buy a GE stove, then GE gets your money. If you buy shares in GE, then GE doesn’t get anything. If your stove is defective and you get a refund, that is returning money to customers. If GE has cash lying around and hands it out to shareholders, that’s not returning money to customers—that’s a windfall.

What it means to be a shareholder is that you obtain a fraction of control over the company’s assets. Those assets include its fixed stock of buildings and factories, its patents and trademarks and copyrights and brand value. They include contracts with employees and suppliers. And of course the profits a company accrues and any cash it may have piled up from past profits count as assets. The managers of the firm more or less work for the Board of Directors, which more or less works for the shareholders, so giving the shareholders money is something managers might want to do.

But even so, dividends are a somewhat perverse way to do it. When a firm such as GE flushes cash out in this way, the good news for shareholders is that they get money. On the other hand, the value of the shareholders’ claim on GE’s assets declines. The money in your pocket used to be in GE’s corporate accounts as a GE asset; all that changes when the funds pass from the corporation’s bank account to yours, and you as a shareholder have to pay taxes on the income.

The advantage, of course, is that you can use money in the bank to buy a car or make a down payment on a house. And with the vast majority of shares owned by the richest 10 percent of the population, shareholders can afford to cut the IRS in on the action.

But this is still a strictly inferior option to using corporate cash on a share buyback. When a firm uses its money to purchase stock in itself, it does two things. First, it makes shares in the firm scarcer—thus potentially increasing the value of the remaining shares. Second, it gives shareholders an opportunity to cash out by selling stock. In other words, shareholders who are hungry for cash get their money (and pay taxes on it), but shareholders who’d rather own a slice of the company just keep on owning stock. It’s like a DIY dividend for those who need fast cash. Even buybacks are a fairly lame option for companies with growth potential—that’s the problem with Icahn’s effort to turn Apple into a piggy bank—but if your firm genuinely has nothing useful to invest in, this is the way to go. 

In comparing buybacks with dividends, the only real disadvantage is that buybacks look unattractive when stock market prices are relatively high. That’s one reason you’re seeing dividend hikes this quarter. With the stock market more expensive than it’s been in years, firms are a bit leery of investing in their own shares. A CEO could, of course, simply admit that his company’s share price is high already and so the time has come for patience. But with executive compensation excessively linked to short-time stock price movements, managers rarely have an incentive to call for patience.

The impatient move that would benefit the economy would be for a cash-rich firm with an already high share price to invest. Hire more people and do more stuff, upgrade the training of your existing workforce, reward your better employees with raises and bonuses so they don’t go elsewhere, cut prices to build customer loyalty. That’s how profits lead to rising incomes, and how rising incomes lead to demand for the stuff businesses sell.  

Dividends, by contrast, have a weak and indirect impact on the economy and don’t really serve anyone’s long-term interests. We’re left hoping that rich shareholders will spontaneously develop enough appetite for extra yachts to push the economy forward. It’s a broken economic model that only deepens the disconnect between the stock market recovery and the ongoing labor market slump.

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