Comment: Dividends are cyclical too, Andy Haldane

Bill Jamieson. Picture: TSPL

Bill Jamieson. Picture: TSPL

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Companies are paying out too much in dividends. Shareholders have too much power in corporate affairs. And company law should be changed to allow more power for other “stakeholders” – customers and employees. So says Andy Haldane, chief economist at the Bank of England, in a critique that will be seized upon as compelling evidence of broken capitalism.

Now it is certainly true shareholders appear to be enjoying a dividend bonanza. Payouts hit £29.2 billion in the three months to June, the most of any second quarter, while underlying payouts – excluding special dividends – reached £28.3bn, a record high.

And there is resonance, too, in his assertion companies are not investing for the future as much as they should. His critique of short-termism – a focus on immediate gains rather than long-term prospects – is well established.

But in other respects, Mr Haldane has described a universe few investors will recognise. A low level of corporate investment may require structural change. But attacking dividend policy is the wrong target.

Take, for example, his assertion that one possible major cause of this short-termism is the nature of UK company law, which gives most decision making power to shareholders.

Anyone who has attended a shareholder annual meeting will be familiar with the marked lack of power investors wield over corporate boards. For the past 25 years constant “shareholder revolts” over excessive boardroom pay have fizzled out in failure. Nor can it be argued that institutional investors have wielded excessive power. Most have opted not to exercise that influence and it is only recently that institutional investor activism has emerged as a force for change. And there are few cases I can recall where institutional investors have used their power to compel companies to pay out more in dividends than in investment for future growth.

That the total dividend payout looks big by comparison with past years glosses over key features. When total market capitalisation rises, it should not be an occasion for concern that the totality of dividend payments, too, are higher than in previous years.

Also high dividend payments are concentrated in relatively few companies and sectors. Take out tobacco, big pharma, and mining and commodity companies – far more heavily represented in the FTSE-100 than 25 years ago – and the market dividend would be little higher than in previous cycles.

The level of dividend pay-outs is also influenced by special factors. For example, in the most recent figures, banks were the biggest contributors. After years of little to no dividend growth, headline dividends were up by a third on last year, and contributed more than a third of UK dividends for the quarter.

And dividend payments – like the market overall – are cyclical. Today we may be at or near the peak of dividend sustainability. In recent weeks fund managers have expressed concern over the thin level of dividend cover – the degree to which payouts are covered by retained earnings – or their vulnerability to market setback.

This month has brought as warning from Thomas Moore, manager of Standard Life Investments’ £188 million UK Equity Income Trust. He has now sold off some of the biggest companies in the portfolio such as BP, Shell, and HSBC on concerns over “horrific trends” in dividend cover – the ratio of earnings to the amount paid out in dividends to shareholders.

“If you have a look at the top ten most widely held stocks, quite a few are seeing declining earnings on a five-year view. All of [them] like to grow their dividends but only a few are growing their earnings. The net effect of this is that the dividend cover for FTSE-100 companies has come down because dividends are growing faster than earnings in companies such as GlaxoSmithKline and Shell”.

This concern is shared by Artemis Global Income manager Jacob de Tusch-Lec, who says the market’s “dividend aristocrats” are now expensive, relative to their history and market.

“What happens when rates rise and investors who rushed into these stocks for yield, rush back out, returning to the bond market en masse?” He has cut so-called “bond proxies” in his fund by removing European utilities – constrained by regulation – in favour of US cyclical stocks with greater growth and value opportunities.

Promoting longer term company investment is more complex than simply slapping controls on dividend payouts. Reformers who advocate wider “stakeholder presence” through representation of staff and customers make light of the daily pursuit of companies to maximise customer numbers and revenues as a compelling feature of consumer capitalism, while firms compete every day to attract skilled and qualified staff. The culture within companies is now much more collaborative and consultative than was the case 20 or even ten years ago.

For these reasons Mr Haldane may have started a debate on the future of quoted companies. But it is far from being the last word.

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