The American Spectator

Reader Mail

Dividend Divisions

1.6.03 @ 12:01AM

DIVIDEND AND RULE
Re: Michael Craig's The Groucho Marx Theory of Dividends:

Michael Craig is wrong on his theory of dividends. They are not an inefficient use of capital but part of the cost of capital. Double taxation of dividends only increases that cost of capital. Every graduate with a degree in finance, accounting, economics knows that. Because dividends are taxed twice, they make the cost of equity sources of capital more expensive than debt. The only way to reward cash to stockholders in a tax-advantaged way is to buy back stock -- something that many companies do and is considered a good sign by many investment experts.

To say that paying dividends is a management failure is wrong. Often the most economically efficient use of capital is for a firm to return some of that capital to stockholders who can better invest that money elsewhere. Taxing dividends unfairly causes companies to over-invest in unwise projects and borrow too heavily. Corporate history is full of tragic episodes of companies withholding dividends, borrowing more and going on a binge of unwise acquisitions.

Evidence from some studies suggest that the stocks of large companies that pay higher dividends perform better. Growth companies with super high growth rates should reinvest their earnings into their business. But large successful companies that cannot maintain super high growth rates because of their large size and market shares should send some earnings to their owners and allow them to diversify their portfolios on their own. Lowering taxes on dividends will make this easier.
-- Jim Moroney
Cumming, GA

Regarding Michael Craig's rant against dividends, where has he been for the past ten years? If ever there were a time to reconsider the heads-I-win, tails-you-lose attitudes of corporate management, this is it.

Leaving America's management teams with too much cash is like giving a sailor shore leave, a pack of Trojans, and a case with Jack Daniel's. Something good might come out of it, but what are the odds? If he loves Bill Gates, how does he feel about Dennis Kozlowski? Or Kenneth Lay? Or Bernie Ebbers? Or the United Airlines team? Or the SwissAir management team? Or the geniuses at Global Crossing? Or the bright boys at Federal Mogal?

Fact: academic studies show that most corporate m&a transactions don't work out for the buyer.

Fact: AT&T's shareholders probably would have been much better off if the company had continued a regular, high payout rather than stumbling through the m&a underbrush in search of a telcom El Dorado. And this is one of Craig's examples of a company that did it right!

Fact: Most CEO's think they own the goshdurn company. They don't have any trouble finding a way to get a current, cash-based return for themselves. They ought to extend that thinking to the shareholders who really do own it.

There is no scarier sight to than a CEO with a wad of cash in the bank and a yearning to reshape his industry.

Get that money to the shareholders!
-- Leland E. Hutchinson
Chicago, IL

Companies don't pay dividends because they think you have better ideas than they do. It's because they don't have current projects that will meet their minimum requirement for internal rate of return. You don't necessarily need a better idea yourself. You can do what you like with the money. Buy other stocks in companies that can use the capital. Buy more Microsoft stock if you like. They beauty of the process is that you decide. You might wind up funding the next great American success story.

Hammering dividend payouts with additional taxes curbs your freedom of action and results in the government wrongly influencing capital markets. Another result is companies end up holding mountains of unused cash which invites corporate raiding (another story altogether).

It's ironic that you should choose Microsoft as an example since the government has been trying to curb their activities for the past five years. No one would be shocked to get the letter you imagined from Bill Gates ever since the government has been trying to keep them from making money.
-- Ed Callahan

Regarding your article on dividends, a couple of thoughts. First, a Board's primary objective should be to maximize shareholder value, which can be effected through capital gains (i.e., reinvesting for future growth) or through dividends (i.e., return of capital). As I see it, reducing or eliminating the tax bias against dividends is beneficial precisely because it will promote the free flow of capital toward its most productive use. If a company determines that the next growth project would deliver subpar returns on capital, then the Board should return the capital to the business owners and allow the individual shareholders to redeploy the capital as they see fit. Perhaps some other management team in some other business has a use for the capital that is superior. Better that capital be returned and redeployed than be bottled up in a company with suboptimal return potential or that has to swing for the fences to diversify -- that's just bad corporate finance. Finally, I agree completely that any attempt to fix the inefficiency should focus on corporate deductibility rather than tax breaks to individuals.
-- Paul Berman

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