IA To Barron's on Dividends: Let the Market Decide

Dividend strategy, among the most contentious of capital structure policy issues and one about which I've written before, graced the cover of Barron's this weekend. The thrust of the story: that dividend payouts are too low and that buybacks are overused. The story, penned by Andrew Bary, is both well-written and well argued yet misses an important point: that the market - namely, institutional investors - appears to be pretty comfortable with corporate financial policies, at least on an aggregate basis. Sure, there are isolated circumstances where institutional shareholders may clamor for higher regular payouts, but in general, the market is trading pretty well given current corporate behavior. And I don't really buy the argument put forth by Henry McVey of Morgan Stanley concerning the impact of retail demand for dividends:

"A lot of corporations are missing the seismic shift in retail demand for yield," says Henry McVey, chief investment strategist at Morgan Stanley. As tens of millions of baby boomers start retirement, the demand for yield-oriented investments will climb. McVey notes that Americans over 65 have equity portfolios with an average yield of 2.6%, versus 0.8% for those under 65.

Much of this money is going to be run by institutions, not by retail, so I'm not really sure if this "seismic shift" really matters. I think not. And while I'm at it, I also don't really buy the following argument governing the motivation of corporate-sponsored buybacks:

Corporations are wedded to big buybacks because executives believe that repurchases are the best way to lift share prices. And higher prices enrich corporate managers who have lush stock-option packages. Individuals, meanwhile, can benefit from buybacks to the extent that they defer paying capital gains.

Corporations like buybacks because they are flexible, can be used to soak up short-term excess cash as well as to facilite a more optimal capital structure, and because of the signaling effect they can have on management's view of business prospects. I don't think corporate managements really believe that institutional investors are as dumb as Mr. Bary would have you think. Given my knowledge of corporate finance departments and their decision-making processes, I am pretty confident that the reasons I raised for why buybacks are used are more on point, IMHO.

So while we can prattle on about what should and should not be, the market is saying something: that the current dividend vs. buyback policy is just fine, thank you. And while we can debate the point on a theoretical basis, the fact that the two strategies are tax-neutral and that institutions seem to like the discretionary and signaling aspects of buybacks means that things are unlikely to change. Until institutions begin stand up and begin voting with the pocketbooks, that is. Which means a change in the market. Which is the way things should be, not the way some people think things should be in the financial media eco-chamber. Let us always remember: Mr. Market rules, now and forever.

Comments

[Kartik Agaram]

I don't entirely understand your arguments, but I tend to be skeptical whenever people say 'let the market decide' to argue in favor of a status quo.

Markets are very good at identifying optima in the portions of the state space they are aware of. Like anything or anybody else, however, they can't do anything about information or insight they don't have. That is the whole point of the concept of arbitrage.

Your rebuttals of specific quotes seem reasonable, but the rhetoric is overly general IMO.

[caveat bettor]

Just saw your interesting blog for the first time. Love Schumpeter & love my Wii. Still toiling on Wall St, though, (in a prop trading business).