This week BHP, the largest global mining company, announced
they are to scrap their progressive dividend policy, comically only 6 months
after their CEO Andrew Mackenzie made the contradicting statement “over my dead
body sounds a little strong but it’s almost right”! This news
returns us once again to the age debate: Is dividend policy relevant?
An interesting point to begin with is the fact BHP vowed to
maintain their progressive dividend policy by increasing the annual dividend by
2%, despite their share price and first half profits tumbling 92%! (Stringer,
2016). It is clear that the directors disagree with Modigliani and Miller’s
(1961) dividend irrelevance theory. This is congruent with the popular view
that dividend policy is important, as
evidenced by the large amount of money involved and the attention that firms,
security analysts, and investors give to dividends (Baker & Weigand, 2015).
Personally I believe their decision to initially raise the dividend was to try
raise investor confidence even though the market conditions are in a state of
turmoil, with the price of a barrel of oil falling from 114.83p per barrel on
april 01, 2011 to just 26.05p on feb 01, 2016 (Kumar, 2016). In a rather
fitting quote, Andrew Lapping, deputy chief investment officer for South Africa-based
fund Allan Gray Ltd., recently described miners promising ever-rising dividends
as a “joke.” (Hoyle, 2016). It is likely BHP took Linter (2007) and Gordon’s
(1959; 1962) “Bird-in-the-hand theory” into consideration when deciding to
continue their progressive dividend policy. In their research, Linter and
Gordon argue that dividends are preferable to capital gains due to uncertainty,
and that investors would rather have the money now rather than leave it tied up
in uncertain investments. This approach is likely to raise concerns amongst
BHP’s investors.
Personally I
agree with the dividend relevance theory, due to the fact Modigliani and Miller’s
theory was based upon a number of assumptions, such as the reliance of perfect
capital markets, no issue cost for securities and no tax. In reality, these
factors have to be taken into consideration. Unfortunately we do not live in
strong form markets, and there are transaction costs and hefty taxation
implications.
Source: (Wsj,
2016).
BHP’s decision to scrap the policy has largely been
influenced by the rest of the market’s attempts to improve their financial
position by also cutting dividend. All
the main players have now cut their dividend, including Rio Tinto and
Anglo-American. From this ordeal it has been made clear to myself the
implications dividend policy has on the shareholder’s perceptions of the
company. This dividend cut, which BHP were forced to do to try and savour their
credit rating, even though this has been downgraded by Barclays and HSBC to “underweight,”
has resulted in BHP’s stock falling significantly.
From this ordeal it has been made clear to myself the
implications dividend policy has on the shareholder’s perceptions of the
company. This dividend cut, which BHP were forced to do to try and savour their
credit rating, even though this has been downgraded by Barclays and HSBC to “underweight,”
has resulted in BHP’s stock falling significantly, as illustrated below. This highlights how short term the market is,
because now the short term returns have been cut a lot of shareholders have
began to sell, hence the price drop.
Source: (Cunningham,
2016).
Reference List
Baker, H., &
Weigand, R. (2015). Corporate dividend policy revisited. Managerial Finance,
41(2), 126-144. http://dx.doi.org/10.1108/mf-03-2014-0077
Cunningham, T.
(2016). BHP Billiton tumbles amid fears of dividend cut. Telegraph.co.uk.
Retrieved 14 March 2016, from
http://www.telegraph.co.uk/finance/markets/marketreport/12095897/BHP-Billiton-tumbles-amid-fears-of-dividend-cut.html
Hoyle, R. (2016). BHP
Billiton Slashes Its Dividend. WSJ. Retrieved 14 March 2016, from
http://www.wsj.com/articles/bhp-billiton-slashes-its-dividend-1456177003
Kumar, D. (2016). Oil
plumbs new lows below $27 as oversupply woes persist. Reuters.
Retrieved 14 March 2016, from http://www.reuters.com/article/us-global-oil-idUSKCN0UY04U
Stringer, D. (2016). BHP Cuts
Dividend for First Time in 15 Years on Profit Drop. Bloomberg.com.
Retrieved 14 March 2016, from
http://www.bloomberg.com/news/articles/2016-02-22/bhp-cuts-dividend-as-first-half-profits-fall-92-on-price-rout
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