When dividends per share (DPS) decrease, it can significantly impact shareholder income and market perception. For instance, during the 2008 financial crisis, many financial firms cut dividends as profits fell. Citigroup reduced its quarterly dividend from $0.54 in 2007 to $0.01 in 2009, leading to a sharp drop in its stock price and investor confidence. This reflected broader concerns about the company’s profitability and financial health, echoing similar moves across the banking sector which saw overall reductions in investor yields and shifts in investment strategies.
Reinvestment of Profits
Companies often choose to reinvest their profits rather than pay them out as dividends. In doing so, they effectively bet on their future rather than rewarding the receiver in the present. For example, in the case of Amazon, potential dividends appear to have been ploughed back into increasingly grandiose efforts to expand the company, almost as if Amazon were using opportunities to pay dividends as clues to try something bigger. Reinvestment has taken Amazon into markets and technologies that the vast majority of companies can only dream of, making it one of the world’s biggest retailers and a leading player in cloud computing.
Common areas where reinvestment is often directed include spending on research and development, expanding the markets in which a company operates, and investment in new technologies or upgrading existing ones. A tech company might choose to pay out $0.60 per share in dividends rather than $1.20, using the remaining $0.60 to invest in an innovative new product. While this approach is likely to reduce short-term DPS, the new product may arrive at a time that dramatically changes the company’s market position, dramatically increasing long-term profitability.
A similar example can be seen in Apple’s investment in the ecosystem of devices and services. Profits returned to its own development have allowed the company to improve and introduce new products that are impressive to the receiver, not to mention achieving a high stock price to investors. Warren Buffet’s famous saying: “Our favorite time frame is forever.” Consequently, companies that reinvest their profits are not in the business of calling for “big gains today” but are focused on achieving even greater gains in the future. This approach requires considerable self-assurance and a clear view of the company’s strategic focus. It should remind the shareholder that a particular company is not for short-haul investors.
Debt Reduction Strategies
Some companies’ approach to improving their financial health includes a series of measures aimed at decreasing their exposure to debt, for instance, suspending or limiting dividends. This change in strategy serves to enhance the organization’s balance sheet and, eventually, may have a positive impact on the stability of the company’s stock. An example is the recent announcement of the AT&T dividends’ reduction . The suspended payments will help the telecommunications business to manage its tremendous $180 billion debt issued to make sense of the series of acquisitions after the 2007 crisis.
Once the firm has managed to avoid debt, it can allocate the saved resources to a variety of other, most beneficial purposes. These often include strategic acquisitions, investments in new markets, and, in the case described, facilities’ construction. Such colossal investments can bring a profit to the organization that will overshadow the value of previously paid-out dividends.
For instance, in the situation considered in this paper, AT&T had to cut the amount of its payouts from $1.50 to $0.30 per share. After this happened, the resources that otherwise would be paid to stockholders will now be spent to address the debt. In the context of the years to come, this step may look quite banal but, at the same, will strengthen the company’s financial position, improve its flexibility, and ensure the investors’ profit.
The situation with Oracle provides another example of implementing this strategy. In June 2020, the organization issued $10 billion worth of debt. It can serve a variety of purposes, one of which may be to continue buying off its shares from its stockholders up to the moment the dividends’ proportion payment will be reduced.
Consequently, under a specific set of conditions, taking a debt for buying stocks may be a beneficial solution to optimizing the organization’s capital structure and achieving the maximum benefit for the shareholder.
Economic Downturns
An economic downturn is an essential illustration of a force majeure event that is likely to deprive any company of the opportunity to continue dividend payouts. For example, both the economic decline of 2008 and the current epidemic of Covid-19 have had a significant positive effect on the development of a variety of industries. The example of the former crisis is largely linked to the devastating consequences for many major banks and financial institutions that declare the sharp reduction and the necessity of canceling dividends, due to the unprecedented decrease in earnings and an increase in the degree of pressure from market regulators.
This event is illustrated by the case of Citigroup, which was one of the world’s largest banks at that time. However, in 2009, its quarterly dividends per share decreased by $0.16 to $ 0.01 due to the record loss of $ 27.7 billion. As a result, the amount served as a significant part of the payment of two state financial support programs for Citigroup .
It is a logical and expected step since the main signal of the upcoming decrease in consumer demand and a simultaneous rise in credit risks and capital costs is that corporations increase the accumulated cash volumes.
As an example, in March 2020, American car manufacturing giant Ford announced a total suspension of dividends will maintain $ 30.3 billion cash in light of subsidies of employees who lost their jobs due to the Covid-19 pandemic . Probably, this cycle of interrelations is best illustrated by the maxim of the well-known investor Warren Buffett: “You discover who has been swimming naked only when the tide goes out. ” .
Shifts in Company Strategy
We often see companies change their strategy to adapt to changing market conditions or to facilitate long-term growth, and they may subsequently change their dividend policy once their strategy changes. Under Satya Nadella’s direction, Microsoft changed its core mission to cloud computing . This shift in the company’s strategic orientation necessitated that it spend large amounts of money on technology and infrastructure. As such, the company may shift the focus away from dividend payments to developing cloud services further, as shareholders often value growth opportunities more than the quarterly dividends they receive. Google, also known as Alphabet, has never paid any dividends to shareholders, reinvesting its profits in a variety of projects and expansion efforts. The company’s investment into artificial intelligence and other next-generation technology will require substantial spending that cannot be financed through dividend payments. These investments will also yield substantial returns in the future, making them appealing to long-term investors, which are the target audience of the business.
Furthermore, the change in strategy often occurs in the context of entering new markets or the acquisition of other businesses. Both of these activities will require companies to have the necessary resources, and paying them out as dividends would decrease their ability to invest in growth opportunities. Apple is an example of a company that has used this strategy, buying other tech companies and integrating their technology into its existing products lines . These acquisitions are mostly paid for from the company’s cash reserves; had these reserves been distributed as dividends, Apple would have had to take out loans to finance the acquisition of the same companies.
Jacks Welch, the former CEO of General Electric, is known to have said, “Change before you have to.” It perfectly encapsulates the ideal behind decreasing dividends as a performance measure. That is, before the company loses too much money, it decides to invest in a variety of growth opportunities or to pay off its debts. This ensures that the company is competitive and fiscally healthy, securing long-term prosperity, which, ultimately, benefits the company’s shares in a way that dividend payments do not.
Legal or Regulatory Changes
Changes in legislation and regulations have a great impact on the ability of a company to pay dividends . For example, when the crisis of the financial system broke out in 2008, the major banks were adopting new laws in the USA, such as the Dodd-Frank Act, which imposed on banks higher reserves against the deposited assets . Thus, such banks as Wells Fargo and Bank of America could not return to their shareholders more than several cents of each dollar of its assets . One more example of the impact of regulations on dividends is the utility sector of the economy. The rates of the companies of that sector are based on regulatory review .
If the companies will be allowed to charge less, they will have lower profits, which will affect the amount of dividends. For example, if the regulatory bodies impose lower rates on the companies of the sector, as it happened in Great Britain, the latter will have to decrease dividends .
Telecom companies suffer from the same problems, as they had to compete after the fees were vastly restricted by the European Union .
Tthe companies have to change their strategies of capital allocation, which results in the decrease in the amount of dividends paid to the shareholders of the companies . As the well-known saying of Benjamin Franklin that “an ounce of prevention is worth a pound of cure” says, the integration of the regulations in order to guarantee stability of the operations of the companies may require for restrictions or the decrease in the payment of dividends. However, in such a way the companies preserve their propensity to default and, therefore, ensure their good operation in the future.
