This article examines the payment of stockholder dividends and how policies are set or how practices evolve that govern the payment of dividends. The scope of stockholder rights is explained along with methods that stockholders utilize to assure that their rights are properly manifested when investing in a company. Conflicts of interest between stockholders and corporate executives that may result in stockholders not receiving dividends are explained. Financial scandals of the early 21st century are reviewed as well as laws, regulations, and management practices that have been implemented to help prevent companies from releasing false or misleading financial reports.
Keywords: Dividends Policy; Financial Statements; Public Accounting Oversight Board (PCAOB); Sarbanes-Oxley Act; Stock Dividends; Stockholder rights
A company's dividend policy provides guidance on when to pay stockholders dividends or when not to pay the dividends and use profits for other purposes. When profits are held and not paid out as dividends, funds can be used for new product development, market expansion, or acquisition of other companies (Sheppard, 2008). Other factors that impact dividend policy in some companies include corporate tax situations as well as the impact on the tax conditions of the shareholders receiving dividends (Cohen & Yagil, 2008). The type of stockholder that has invested in the company may also impact dividend policy. When a company is publicly traded and there is institutional ownership stock by investment funds or retirement funds, there may be more pressure to pay dividends (Guo & Ni, 2008) (Aivazian, Booth, & Cleary, 2006).
Why Pay Dividends?
Dividends can be paid for several reasons. In some cases, dividends are paid to satisfy existing stockholders (Azhagaiah & Priya, 2008) (Ben Naceur, Goaied & Belanes, 2006). When high-level executives hold large quantities of stock, paying dividends can be viewed as a form of a bonus for the executives.
In other cases, dividends may be paid as a signal that the company is successful. This may influence the opinions of stock analysts or future investors in the company (Li & Zhao, 2008) (Dickens, Casey & Newman, 2002). Companies have attempted to use dividend payouts as a way to favorably influence their stock price. Many have found that announcing a large dividend pay out, or making a larger than normal pay out of dividends, may result in improved stock prices for a short time — there is little supporting evidence that the strategy is always effective (Wann, Long, Pearson, & Wann, 2008).
Alternative Investor Incentives
Although dividends are the primary mechanism by which an investor increases their wealth through company investment, there are other means by which companies can reward their investors. Stockholder wealth can also be increased through stock buy-back programs where, instead of paying a direct dividend, a company buys stock back from investors at a preferred and attractive price (Wiemer & Diel, 2008). Another approach aside from dividend payments or payouts to shareholders is the distribution of additional shares of stock in proportion to the number of shares already owned. This can result in concentrating power in the hands of very few shareholders (Denis, 1990).
The value that a company achieves by paying dividends varies with economic conditions. As the mood of investors shifts, so do their investments. At times, they prefer dividend-paying stocks; at others, they prefer growth stocks such as many of those in the high-tech sectors. Under the Bush administration there was a short-lived effort to promote dividend payout as a practice to lower taxes on dividends for recipients. This had very little impact on the number of companies paying dividends (Bank, 2006)(Henry, 2003). However, the managers of NASDAQ firms generally concur that a consistent history of dividend payouts helps to sustain company value, at least in the perception of investors (Baker, Powell & Veit, 2002).
The big question about whether to pay or not to pay stock dividends concerns who benefits from firm wealth. Stockholders are obviously seeking a return or they would not have invested in the company. Managers, on the other hand, may be both stockholders as well as employees that receive bonuses such as revenue growth or increased market share. Thus stockholders seek ways of assuring their rights.
Methods of Assuring Stockholder Rights
Some form of shareholder rights is a part of corporate law in most countries throughout Europe and North America. These rights may include the right to hold periodic shareholders' meetings and be provided annual or other reports from management. In addition, in most situations stockholders will usually have the right to receive dividends paid out of corporate profits. In the event that new stock is issued, existing stockholders may have the right to purchase shares prior to public sale ("Shareholder rights," 2008). The more established the shareholder group in age, organization, and tradition, the more likely it is that there will be dividends paid. This rewards the shareholder for investing their money and supporting the company over a long term. It is also seen as a method of keeping control of wealth and preventing managers from using the funds solely for their desired purposes (Jiraporn & Ning, 2006).
Boards of directors control a corporation through a governance process. Laws relating to corporate governance have been evolving around the world. The Organization of Economic Cooperation and Development (OECD) has provided a framework for countries to structure their laws and to help guide boards of directors to develop their own governance approaches. The OECD framework promotes both stockholder rights and board responsibilities. The scope of shareholder rights ranges from timely access to accurate information, accurate financial statements, voting power, and redress when their rights are violated. The framework also charges the board of directors with a range of responsibilities including monitoring the management of the company, reviewing and approving corporate strategy, assuring the accuracy of financial statements, and deciding the compensation and tenure of high-level executives ("OECD principles," 2004)
Shareholders have become more organized and more active over the last two decades. This activism has taken many shapes and forms. In some cases, shareholder activism can be motivated by desires for social change or protection of the environment achieved through changing corporate policy or managerial practices. Most often, such activism surfaces in the form of a resolution to be considered at an annual meeting. Few such resolutions pass and when they do they are generally considered to be only advisory in nature. These resolutions do help raise concerns and may actually be acted upon, but in informal manners (Hendry, Sanderson, Barker & Roberts, 2007). There are, however, many criticisms of shareholder activism including the fact that it is expensive, time consuming and, many argue, not very effective (Thomas, 2008).
The intensity level of activism and the direction of the activism of stockholder groups are changing considerably. Some of the more high-intensity groups now practicing shareholder activism include religious organizations and institutional investors holding large amounts of stock (Van Buren, 2007). Among the most active institutional investors are public pension funds, union pension funds, mutual funds and hedge funds that hold large blocks of stock (Minow & Hodgson, 2007). Religious organizations have well-tuned capabilities when it comes to putting pressure on corporations and at this time, they do seem to focus on socially oriented agendas. Institutional investors tend to focus on the financial stability of the held company and for the last several years have spent considerable time and effort on reducing high managerial salaries.
The activism of the institutional investors, especially those that have considerably high levels of funding from retirement funds of labor unions or public employees, has been fueled by relatively recent events. When Enron and WorldCom collapsed, several investment funds and retirement funds belonging to thousands of individuals lost value. Individual members of retirement funds were outraged and angry with the people managing their retirement funds. The fund managers in turn had little choice but to pass this anger on and to do so in a manner that better helped to protect the value of the retirement funds for which they are responsible (Minow & Hodgson, 2007).
As a result of numerous corporate failures, the Sarbanes-Oxley Act was passed in 2002 by the United States Congress. This act was a very significant step in the regulation of publicly traded companies and was intended to help protect investors by requiring more stringent controls on corporate financial reporting and disclosures. As one of many control mechanisms, the act established the Public Company Accounting Oversight Board (PCAOB). "The PCAOB is a private-sector non-profit organization that is charged with overseeing the audits of public traded companies" (Walther, 2009). These companies are regulated by numerous securities laws and must submit regular reports to the Securities and Exchange Commission (SEC).
One of many issues surrounding the massive financial collapses of Enron and WorldCom was the accuracy and reliability of internal audits. These audits are provided to the board of directors and the stockholders as accurate depictions of the financial health and condition of a publicly traded company. Reports are also filed with the SEC as a matter of public record. The Sarbanes-Oxley Act addressed the reliability and independence of audits and requires that any and all documentation regarding financial statements be persevered. (The urban legend surrounding the Enron collapse is that managers in the company and those in the independent auditor's office were shredding documents that showed the fabricated annual financial statement. This is like Richard Nixon erasing tapes.) The act also holds executive officers and boards of directors more accountable for the accuracy of financial reports and prescribes rather severe criminal penalties for false or misleading reports ("Sarbanes-Oxley Act," 2006).
Conflict of Interest in Dividend Policy
In the first decade of the twenty-first century there occurred numerous business scandals that make television soap operas look dull in comparison. Some very large or long-standing companies in the United States went bankrupt or got into very complex a deep financial problems. A partial list includes Enron, WorldCom, Xerox, Global Crossing and Halliburton Oil Services. It was one thing to be in the news as a poorly managed company. Citizens for the most part would find that laughable. But these scandals not only rocked financial markets with losses, they also resulted in job loss and drew the attention of the public as well as the United States Congress. Eventually, some chief executives were even convicted of fraud (Bhamornsiri, Guinn & Schroeder, 2009).
The big question on the minds of many ordinary citizens and thus eventually the minds of regulators as well as lawmakers was about the competence of the highly paid executives of these failing companies. The news of the large salaries and bonuses being paid to executives as workers lost their jobs led to considerable public outrage about how private corporations are managed, and especially about executive compensation (Thomas, 2008). Shareholder activism on executive compensation accelerated and has resulted in the ouster of several CEOs or the reduction and restructuring of compensation packages (Nicholas, 2007) (Melican & Westcott, 2008).
As investigation after investigation unfolded, questions about executive competence evolved into questions about honesty. Among the key questions about executive honesty was to...
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