Is The Dividend Culture Bad For The Economy And Society?
Divided payments are an important benefit to holding many shares.
But while they can be attractive, a focus on them is damaging both for society and for the growth of your wealth.
Why Investors Love Dividends
At first glance, it’s easy to understand why dividends are appealing to investors.
They provide an immediate and regular reward for your investment. For retirees in particular, they can be an invaluable source of passive income.
And for the active investor, the money can be reinvested to create compound growth.
For those looking to make big gains, there are often better options than dividend-paying shares, but dig a little deeper and you can see why dividends still appeal.
Quality dividend-paying shares are often less volatile than growth-oriented ones. They can be used to balance riskier investments, creating a stable growth portfolio.
They provide more control over where your capital is invested, instead of leaving it in the hands of executives.
Investing in growth shares and periodically selling some off might provide more income in theory, but it’s less reliable, as you may have to sell at a bad time for the stock price.
Overall, dividend stocks make a good safe bet.
Why Businesses Love Dividends
The popularity of dividends explains why they’re so enticing for the issuing businesses. They create an appealing incentive for investment, supporting the share price.
For the people at the tops of businesses, they also have a particular appeal.
Dividends contribute to shareholder returns, which are often used as a measure of performance for business leaders, and so affect their salaries.
By pleasing shareholders, dividends can be used to justify bonuses and fend off rebellions over high executive pay.
Many executives receive shares as part of their bonus package, and so profit directly from those dividends.
As well as these practical considerations, there’s a rhetorical one.
It’s easy to demonstrate the total value of a dividend, whereas the effect of reinvestment can take a long time to show and be dispersed or tough to measure.
When arguing for how well a business is doing, dividends are a useful tool.
Why Is It a Problem?
None of this sounds bad until you consider the consequences.
Dividends come at the expense of capital investment and prioritising them can undermine the broader health of the business.
There’s an opportunity cost in projects, staff development, and technology that don’t receive that money.
That cost reduces productivity.
In some cases, putting money into dividends leads to heavy borrowing, incurring interest payments and savaging the company’s balance sheet.
This creates shares like Vodafone, where the company is so indebted that the dividends are the only appealing feature, forcing a vicious cycle of commitment to further dividends.
Corporate debt has risen dramatically since 2010, and dividends are contributing to those broken balance sheets.
Greater reinvestment improves productivity and wage growth, boosts cash flows and profits.
It’s good for the company and the wider economy.
It’s notable that the biggest sectors for dividend payments are currently oil, mining, banking, and pharmaceuticals – all industries that have seen a great deal of criticism and calls for reform.
Dividend payouts are part of a broad strategy of defending the status quo rather than tackling long term social and economic problems.
They’re a way of fending off systemic reforms and come at the price of investment in changes such as developing renewable energy.
In short, dividends are damaging both businesses and wider society.
The Dividend Dilemma
So why aren’t shareholders up in arms or businesses breaking out of this model?
Because this situation has the same dynamic as one of the world’s most famous logic problems, the prisoner’s dilemma.
Like the prisoners in their theoretical cells, executives can choose to cooperate with each other in making the situation better – in this case, by moving away from dividends.
If they all do that, then we get the best overall option.
If none of them cooperate then we keep heading down a destructive path. But if some move away from this focus while others don’t, the ones who’ve tried to improve their businesses and the world will seem like failures by current metrics.
They’ll lose out while the bad players will benefit even more by comparison.
That means there’s always an incentive for executives to stick with an over-emphasis on dividends, ride out the benefits, and move on before the consequences kick in.
As an individual investor, you’re better off avoiding businesses that rely too heavily on dividends. But for the market to improve, the situation is going to take systemic reform.
And right now, anyone who could make that happen is busy profiting from dividends.
Paul Connolly
Paul Connolly has been a journalist for more than 20 years, as a reporter and editor for Argus Media, Reuters, The Times, Associated Newspapers and The Guardian. He has covered Islamic Finance for Reuters in the 1990s. Paul has since helped launch three newspapers, as well as reported from Tokyo, Los Angeles and Stockholm.
