BHP Billiton - Progressive Dividend FLOP

 "Big business should re-balance demands of shareholders with wider issues"

BHP made 61% less in pre-tax profits, yet still made decision to increase dividends by 2%. Why, despite the fact that BHP didn’t make as much profit as it thought it had, would the company increase dividends by 2%?  The words I’m looking for here are ‘progressive dividend policy’, which involves management committing to a rising dividend year-on-year for the company. The company plans to do so by accelerating cuts in operating and capital spending to ensure this pay-out, although I question whether this pay-out would be sustainable in the future and secondly, is it wise cutting spending. BoE’s chief economist Andy Haldane argues that if BHP commits itself to this policy, is the company potentially running the risk of eating its own business by not being able to invest in new products and services. In this article, he also accuses business leaders for “serving the short-term interest of shareholders at the expenses of the wider economy.”

Looking back at MM’s theory of dividend irrelevance (Residual Dividends Policy) dividends should be paid from retained earnings after meeting investment needs from positive NPV projects, MM argued that if all projects can’t be met, then a company should alter its capital structure to finance these projects (i.e. bank loans) but ultimately, TAKE ON MORE DEBT. This was apparent in their theory against an optimal capital structure which I discussed in my previous blog on American Apparel.

So the question remains, does dividend policy help to maximise shareholder wealth? 

Not surprisingly, the finance literature poses considerable debate on whether dividend policy plays a role in achieving this goal and whether it affects firm value. One view, attributed to Miller and Modigliani (1961) and echoed in Black (1976), suggests that dividends are irrelevant for firm value and possibly value-destroying, which is evident in BHP’s case because the company is serving the short-term interests of shareholders. BHP have a progressive policy of dividends, however is willing to decrease investment in growth to fulfil its yearly claim. While dividend policy may not maximise shareholder wealth, it can certainly destroy it. So, should BHP drop its dividends? I would say so, as dividends should relate to performance increases in profits, rather than temporary. With the money returned from dividends, this should mitigate their loss.

Another perspective, represented in the classic works of Williams (1938), Lintner (1965), and Gordon (1959), considers dividends as an important determinant of firm value. Arguably, I would also agree with this statement because to an investor, dividend pay-outs can be seen as a way of assessing the company’s performance, for example; BHP’s sustaining dividend increase is to signal to shareholders that the drop in earnings is only temporary, which is a reason why share price has increased, because more people are buying the shares, and perhaps the best time to. Although I believe if the company would reinvest, likelihood that investors would still prosper from new project and therefore also increased share price.

No universal set of factors is appropriate for all firms because dividend policy is sensitive to numerous factors including firm characteristics, market characteristics, and substitute forms of dividends. The Dividend Puzzle remains an important topic in modern finance. Despite extensive research, considerable debate exists on whether dividend policy plays a vital role in achieving shareholder value.

I had my thoughts on the topic….what’s yours?