« The Biggest GIVEAWAY Ever on AllFinancialMatters! | Main | The MoneyBlogNetwork Welcomes Two New Members! »
Say Goodbye to Dividends?
By JLP | September 9, 2007
I read an interesting article ($) in this week’s Barron’s about how some companies are favoring stock buybacks over dividends. The article highlights a paper written by Douglas Skinner, professor of accounting at the University of Chicago Graduate School of Business, titled “The Evolving Relation between Earnings, Dividends and Stock Repurchases” (click on the title to go to the download page for the paper).
From the Barron’s piece:
Skinner finds that stock buybacks are now being used as substitutes for dividends, even by companies that continue to make payouts. The reason for that appears to be the increased volatility of earnings.
In some ways, says Skinner, repurchases are the superior choice for the issuer because “there’s total flexibility with stock repurchases, whereas you’re committed forever with a dividend.” For obvious reasons, companies want to avoid cutting or omitting their payouts. “With repurchases, you could pay out $3 billion…one period and zero the next.”
My thoughts:
It may be good for business but it doesn’t seem to be good for investors – especially income investors. What would a retirement investor do if companies all the sudden stopped paying dividends?
I think companies should balance dividends with buybacks. If share prices are high, dividends seem to make more sense. When share prices are low, a buyback makes more sense. I also think that we need to quit the double taxation of dividends either by making them pretax for the company or taxfree for the investor.
Topics: Investing | 13 Comments »
September 10th, 2007 at 3:59 am
“Double taxation”? no. The company makes a profit, which is rightly taxed. The company gives a portion of the money to investors – which is income for the investor and is taxed.
That’s not double taxation, and calling it that is you being greedy.
An example of double taxation is – I get taxed on the dividend I received as income, then I go out and spend those dollars to buy something and pay a sales tax.
Multiple taxations on a given dollar is common and proper – if that dollar is changing hands. Actually, every transaction normally entails two taxations – one for the transaction itself (often exempt if the transaction is not to the final user of what is being bought/sold) and then another tax on the profit made by the seller during the transaction.
September 10th, 2007 at 4:06 am
Lots of things are “double” and “triple” taxed. I don’t see why we should arbitrarily eliminate these extra taxes on dividends, which will mainly benefit the rich.
September 10th, 2007 at 5:16 am
I think this is a great article about what companies in today’s markets are facing. I would not be surprised to see companies roll back the amount of dividends they pay while increasing stock buy back plans. However, I doubt many stop dividends completely or all at once; it would likely be a gradual scale down. Otherwise, I think many stocks would lose value, which is what the companies generally try to prevent.
September 10th, 2007 at 7:34 am
You can argue that we shouldn’t eliminate the tax on dividends, but I’ve read at least one credible argument that says reduced tax on dividends (as we currently have in place) is a positive.
As you point out, it is harder to cheat on dividends than on other behaviors, like stock buybacks. By advantageously taxing dividends, we encourage honest behavior in companies. Dividends have certainly become in vogue in recent years, and, although the 00’s bear market has had something to do with that, I have to think the change in taxation was probably part of it too.
Of course the people who benefit from the tax advantage on dividends are people who hold their investments outside of IRA or other tax-advantaged accounts. A regular non-rich mortal like myself is going to generally have investments in a Roth or Tradition IRA-like account and pay tax on dividends just like regular income.
However if I were to die and leave a bunch of life insurance to my non-working wife (on disability), her subsequent investments would necessarily be after-tax. She would be a non-rich person who would benefit greatly from the lower tax on dividends. So it isn’t always the rich who win.
If reduced tax on dividends is a positive, one could argue that going all the way is better. Personally I believe it is more of a balance. If you never taxed dividends, it would greatly nullify the point of IRAs–why should IRAs have contribution limits? You could get an indefinitely tax-deferred investment by buying the whole stock market and you’d never even pay tax on the income it generated. An IRA is pretty pale by comparison with that. Leave your investment to your heirs and they have an indefinitely tax-deferred investment without paying taxes as well, with a stepped-up basis in perpetuity.
The government really doesn’t like perpetual tax-avoidance. It tends to encourage a wealth-based “royal” class and ultimately destabilizes society.
September 10th, 2007 at 9:17 am
I see this trend as a good thing for bonds and REITS, but overall, I think it’s a pretty bad development.
As far as taxation goes, being a guy who likes dividends, I would obviously prefer that they not tax them, but I don’t see that happening. The government can’t balance a budget now; a huge drop in tax revenue isn’t going to make it any easier.
September 10th, 2007 at 9:18 am
Buybacks would only work for awhile as there are a finite number of shares to buyback. They are a great way to return windfalls that may not be repeated. If a company has one or two stellar years then a buyback would permanently increase the future returns to remaining shareholders without handcuffing the company. Dividend reductions are really bad PR, and they usually come at the same time that a company is doing badly.
A company could very very easily make a special dividend payout. I’ve seen them before and they are nice PR too. At year-end the company just declares a one-time dividend in addition to the normal.
In the end every company must pay out somehow. If you think the company you own shares in will never pay a dividend then you own a worthless stock. If stocks are priced higher than their dividends indicate then it should be because investors believe the dividends will grow.
September 10th, 2007 at 9:25 am
Double Taxation: Income at the company level is taxed once. It already is owned by the investor and there is nothing further of value being done in the payout of a dividend. It isn’t a taxation on economic activity like an income tax or value-add tax. So a tax on dividends is just a second tax on the dollars that were already owned by the person they’re being paid to.
I think that we should instead consider the dividend tax to be like a moving the tax rate up more because a corporation is quick advantageous, tax-wise, compared to other forms of income. All the working people want those damn rich folks to pay their fair share after all, right? Except they misunderstand and think that the dividend tax is smaller than their paycheck tax; which it is, but the corporation is also taxed on income which they don’t think about.
September 10th, 2007 at 9:48 am
Phil,
If the same dollar is taxed twice, then it is double-taxation. What you describe in your comment is in fact double-taxation.
Greedy? I think not. I just don’t like paying more taxes than I have to. Are you greedy when you refuse to pay $1,000 for a computer that you know is only worth $900? I don’t mind paying taxes because I realize that we do have to pay for the infrastructure of the nation. What I don’t like is paying more tax than I have to. It’s not greedy,… it’s prudent.
September 10th, 2007 at 9:49 am
Unfortunately the term “double taxation” is seen as representing something truly evil (you can’t tax me twice! That’s unamerican!). In reality, it is a way of life (the income/sales tax example being one) and it isn’t going away soon. As a result, companies try to pay at little taxes as possible (and retaining more cash for their shareholders, which, after all, is their fiduciary duty). Buybacks allow the shareholders to retain more cash and hand less over to the federal government. As such, the term “double taxation” is an important one to consider, but only in a rational analysis, not an emotion sob fest about the unfairness of the current tax regime.
September 10th, 2007 at 9:49 am
Andy,
I’m more in favor of eliminating the tax on dividends at the corporate level.
September 10th, 2007 at 2:13 pm
I’d rather get rid of corporate taxes and have dividends be ordinary income. The way they are now, it actually screws up retirement account planning since dividends in an IRA are effectively taxed at a higher rate than “taxable” dividends.
September 10th, 2007 at 3:15 pm
I wouldn’t be worried about this either way. The existence of preferred stock doesn’t devalue common stock, nor will repurchases have any long term effect. The price of each type of stock will reflect the risks and reward inherent in the instrument.
So what will the person do when his stock is repurchased? Take the cash and buy stock with some other entity. There are plenty of choices.
September 10th, 2007 at 11:11 pm
I’d always assumed that share buybacks have become common because they transfer taxation of profits from dividend tax rules to capital gains tax rules. This is good because capital gains are tax-deferred, much like an IRA or 401k. You don’t get taxed until you sell, which could be 10 or 20 years down the road.
Companies are trying to save investors money.