Monday, 1 August 2016

Debt before Dividends?

This got me thinking, what would be the economic effect of a law that limited companies were not allowed to pay dividends if they were carrying any debt? Anyone got any theories?

42 comments:

Dinero said...

In fundamental principles the aim of a company is to return proceeds over and above expenses to its owners , and so the other question is ,why do companies issue debt, when they could get money from their own shareholders who have cash available for investment.

Dinero said...

18.01 continued

and thus in turn return more of the proceeds to shareholders.

Sean Vosper said...

Well, sometimes companies borrow money to buy back shares which then enables them to pay a higher dividend at the same overall cost. Borrowings are, often at least, to enable leverage which in turn increases payouts. If a firms cost of equity is higher than debt it's more efficient to borrow - and so on. Also, of course it's tax-advantaged.
The fundamentals ultimately work - debt is repaid first, but earns a lower but more assured return, compared to equity - nothing to see here, move on, get an LVT - that's both more efficient and rational, and more fair and just.

Dinero said...

so the question is , why borrow money on behalf of the shareholders when they already have money available

Shiney said...

Why?

What would be the point? I mean, the real point, rather than just 'bashing the bosses'.

Bayard said...

To prevent someone buying a company, loading it up with debt while taking lots of money out, then leaving the company to collapse, thus defrauding the company's creditors and stitching up its employees.

Or, to put it another way, why would a reputable boss want to borrow money to fund a dividend?

Shiney said...

@B

I thought that's what you'd say.

Rich Tee said...

I am reminded here of the rise of the Quakers. The Quakers were successful in business because, in a time of widespread corruption and distrust, they refused to compromise their high values and would only deal with people honestly and fairly. The founders of Lloyds Bank, Barclays, Friends Provident, Clarks shoes, Rowntrees and Cadburys were all Quakers (but look at all those companies now, except maybe Clarks).

But don't look to the Quakers this time. These days they are ridiculously left-wing hippy Marxist types who all work in the public sector.

Mark Wadsworth said...

The first rule is that dividends can only be paid out of profits i.e. after expenses are paid (or if they are at least marched by assets).

This is at individual company level though, so in a loss making group of companies, the profitable ones can still pay dividends.

Most of these accounting "scandals" are no such thing, the Tesco one about timing of supplier incentive payments was quite harmless if you ask me.

But Green clearly has done something a bit naughty because so far he hasn't come up with a single plausible explanation or defence.

@ SV, the so called tax advantages for finance as opposed to share capital/dividends are usually no such thing. People keep saying it but it is not really true and never has been in most countries. Yes, interest is tax deductible but so what? So are wages.

Sobers said...

The effect would be that there was less investment overall in the economy, because effectively this rule means that investment either has to come from shareholders (via share issues) or by the shareholders voluntarily forgoing dividends in order to allow the company to borrow the money required. Both scenarios require the existing shareholders to suffer financially - they either have to invest more of their capital into the business (or suffer a loss of capital if they don't subscribe to the rights issue) or they have to forgo their income for whatever period it takes to pay off the debt taken on. So they would be far less likely to vote for a new investment program than otherwise, leading to less investment overall.

You would also see problems for pension funds, who require a predictable steady income from their investments - if a dividend stream could be cut off suddenly because a company needed to borrow money this would play havoc with pension fund cash flow and the ability to pay pensions. Indeed the pension funds would be unlikely to vote for anything that resulted in loss of dividends.

Lola said...

This is relevant and might be worth a read:-
http://www.telegraph.co.uk/finance/comment/10934713/How-debt-the-sociopath-used-its-seductive-charms-to-kill-innocent-equity-provider-of-social-justice.html

Bayard said...

Shiney, is that because it's obvious?

Mark, yes, that dodge (the multi-company one) has just been suggested to me by my brother.

Sobers, thanks, that was the sort of snag I was looking for. There usually is one attached to this sort of "simple" solution.

Lola, thanks, just what I have been saying for years. Why not do a post on it?

James Higham said...

Borrowing money to fund a dividend does seem off.

Steven_L said...

If corporate bonds follow government bonds into negative yields (and as I understand it, the EBC and JCB have been/are buying corporate bonds) then borrowing to pay a dividend would make perfect sense.

In terms of how to prevent people stitching up creditors, I'd suggest making it easier to lift the corporate veil and go after the controllers own assets / assets they have hived off to relatives where they have 'looted' the company.

Lola said...

B. It's fundamental to how we try to operate here. And it is bloody difficult to do so as we are swimming against the (rip) tide (and I can't swim!).

The article also links to this bloke https://en.wikipedia.org/wiki/Samuel_Budgett Who seems to me to be the absolute epitome of someone who managed to combine capitalism with charity.

Bit busy to do a post pro tem

Lola said...

MW Et al.

Part of the problem with BHS was the pension liabilities. What no-one has been saying is that a lot of these 'liabilities' have increased/invented by government and bureaucratic failure - bad regulation, negative interest rates etc. etc. - the consequence being that companies could be brought down by these liabilities.

I hold no candle for P Green, but I am more cross with government and regulatory failure.

Mike W said...

Just from the main thrust of the points being made above. You would think the 'Super clever' banks J P Morgan and Goldman Sachs would be fighting to give Green a small bridging loan of £500 million, so that he can pay the pension fund and restructure. Surely not hard.Simples.Easy money for them.

Or (they know)his net worth after, UK tax, is next to nothing.

When/before his activities play at the next election someone upstairs may be dusting down the file: 'Fat Maxwell and the 'fall' of the back of his (creditors) Super Yatch'.

Lola said...

MikeW. Ho Ho.

mombers said...

I'm not convinced that the problems with final salary pension liabilities are so much the government's fault. Companies made ridiculous open ended promises to their employees, they should have realised a lot earlier and closed the schemes down and replaced with (employer) risk free defined contribution ones instead. We now have the vicious circle of companies put in trouble by their pension liabilities, weighing down their share prices, which then weigh down other companies' pension assets, etc.

SumoKing said...

There would be no effect.

What you would have is (as usual) a largely empty top holding company/listed top holding with a treasury centre company directly below which would lend to all your operating group cos below.

They would then pay everything they could back to treasury centre via debt repayments drawing down loan money for operating expenses during the year and subject to thin cap rules never become profitable.

Treasury centre would probably have a big loan from top co, loaned down when it was incorporated with share premium or it would be in profit and divi up as much cash as possible to then be shared out to shareholders, who if listed are probably holding less than 10% equity directly but slightly more than 25% when you dig down into nominees and investment companies.

Lola said...

Mombers. Well, it's a combination of factors, with the gummint playing a large part. Yes, employers were ambitious, or rather their actuaries didn't get on top of increasing life expectancy and changes in fund returns post 1991 - the general fall in bond yields. And that meant that fund values were over-estimated as to solvency and employers could take contribution holidays. that was compounded by G Howe having a go a 'fund surpluses' and threatening to tax schemes. Plus all the regulatory crap after maxwell etc. etc.

But most of it is government failure.

Lola said...

Mombers. I forgot ZIRP and financial repression. They have doubled the cost of Pensions.

Shiney said...

Bayard - Yes I assumed that you were looking at it too simplistically and my suspicions were confirmed by your reply ;-D

Wide ranging laws designed to cure a narrow and specific problem are rarely effective - as SumoKing points out it just allows lawyers/accountants to play even more tricks. And they tend to have unintended consequences/side effects as Sobers points out.

mombers said...

@Lola, the government hasn't helped what with ZIRP but my point is that companies in trouble generally look like more like gigantic underfunded pensions with a manufacturing department / retail operation on the side. Even without ZIRP, rising life expectancy would have scuppered their promises. It's not really the business of anyone except insurance companies to take on the risk of increasing longevity and a real shame to see good businesses bankrupted or crippled because of carelessly written blank cheques

Lola said...

Mombers. All true.

Mark Wadsworth said...

@ SK, good one, whatever rules B or anybody else could think up would be easily circumvented by stinkers like thee and me.

DBC Reed said...

Not sure what all the fuss is about. Fans of British capitalism will be more righteously indignant about the latest assault on all that's holy by the stinker Corbyn who is somehow allowed to publish in a national paper: "Labour would reform the takeover code to ensure any corporate buyer has the means to acquire a company without saddling it with debt" Observer 31.vii.16.The Labour Party is suggesting that you have to have the money to take over somebody else's company!Obviously he is not aware that the long Conservative progress to deindustrialisation has been based ,not on old-fashioned company growth (that's what the Germans do for Gods sake) but taking them over for next to nothing and doing a bit of fucking about.Look at all the honours Man U has won since the Glazers gave the club this treatment.And all the fan loyalty! Some people!!

Lola said...

DBCR it was largely the flawed 'economics' of Blair brown balls that drove the explosion in the use of debt.

Lola said...

DBCR it was largely the flawed 'economics' of Blair brown balls that drove the explosion in the use of debt.

Shiney said...

Look you lot....debt has its place. I know. Been there, done it, got the scars and the T-shirt. Me and my business partner saved a business from the death, and 49 jobs in the process, by using it to the max and putting our arses on the line. So no f***ing lectures.

You don't run a manufacturing business in c21st without some form of debt facility somewhere. End of. And to have some idiot who has NEVER run anything, not even a whelk stall, saying you can't get a return on the effort in a tax efficient way (i.e. dividend) until its all paid off is, frankly, bollocks of the highest order and would kill most SMEs stone dead.

Lola said...

S. No-one is per se criticising debt (least of all me - similar story in rescuing my Dad's business after he died). What we are saying is that there is a possible skew away from equity risk capital and debt caused by various government interventions and biases.

mombers said...

I propose a general principle: debt to create new assets = good, debt to buy existing ones is bad. Lots of grey areas between the two of course! Private equity is particularly dodgy I think - without the massively favourable tax treatment it wouldn't make sense. Mergers using debt are also bonkers - simply offer the target shareholders payment in shares.

Lola said...

M. And debt to finance consumption = V bad, as that is 'capital consumption'.

DBC Reed said...

@L As "debt to finance consumption "comes from government borrowing from banks and as banks don't borrow off their customers , there is no debt as such.Perhaps the problem is linguistic.

Mike W said...

DBC Reed above,

That's right banks do not 'borrow' from customers. They are not 'loanable funds' institutions. The funny thing is, this is what Positive Money (100% reserve) wants: to make banks, be, as it were, what folks think they are ie, LFI! At best,at very best, you might say banks actually 'lend' (they have it) £1 in every £250 that goes onto their balance sheets as an asset and a liabily.
But, but, but, DBC Reed, once invented, created, monitised, the debt is real: the state will come after whoever owes the banks this 'madeup' amount!!!

So, more like 'Original Sin' than anything postmodern

Shiney said...

Mombers

Again, accountants lawyers etc will play games.

What is investment? Marketing spending? Is that investment in a new asset or 'consumption'.

What about if I create a Newco, borrow the money and buy a machine. Is that OK? But what if I go and buy a brand from another company? Is that an asset? Or I buy the shares of another company with a load of machines/patents/R&D/stuff I want that they are not using and that I can put to better use?

What about borrowing for working capital?

And what is an accounting profit? Which is what a dividend is paid 'from'. Even though you need the cash to pay.

See... its a bit more complicated out here in the real world.

DBC Reed said...

@Mike W
To complicate matters Skidelsky , Victoria Chick, Steve Keen and 30 others have published a letter in the Guardian (4.viii.16,) which Larry Elliott correctly describes (p2) as an argument for "helicopter money". Would be interesting to see how the bank money creation deniers explain away "Helicopter money." Not to worry a few more years of near zero interest rates and quantitative easing putting up asset prices and they'll get round to something tremendously unconvincing.

Mike W said...

DBC Reed above, 'deniers and Tina's will surely deny they ever said anything of the sort!

I notice the media make sure that fiscal policy (which will have to come in the end) is known by Freedman's simplification, 'helicopter money'. But Keynes deeper understanding of the failure of a pure monetry approach that we have been following is not. 'Pushing on a string' surely captures why the BOE has nothing left and had nothing much to start with. Buinessmen here would tell Carney, to another interest rate reduction, some cheap bank loans, but no return on capital investment in the future; to Feck right off! Mr Shiny, Mr Lola, Mr W et al, will all just keep on piling up the Guv bonds thank you very much.
One for the kids, to paraphrase, that nice Mr Churchill, The British government always does the right thing: Once it has exhausted all the other possibilities.Not long now.

Mike W said...

DBC Reed above,

There are not many 'progressive' left wingers left at The Guardian. Indeed, it comes to something that Jenkins is to the left of most of the useless wankers there and at the BBC and the PLP. He does discuss the hetrodox economists you link to above. He calls the BOE, WW1, 'Chateau Generals'. They have no idea what the front line looks like. Very Good.

He adds:
It is irresponsible to await the chancellor’s autumn statement and a political fiddle with tax rates. The engine of the economy must crash into forward gear. Money must be got into bank accounts, cash cards, shops tills and revenues. The plea from 35 economists published in the Guardian this week for “unconventional measures” made only one mistake. It suggested more spending on state infrastructure, which is just spending delayed.

Not sure about that bit. Does he think Infrasruture spending would not spread down quickly enough?

DBC Reed said...

@Mike W
Very odd: my print copy of the Guardian does not contain Simon Jenkins' article which, in the online version, is clearly dated for today.
I would say that Jenkins' views here are identical with my own and contain all the references to the Government dishing out money to punters that incur the righteous indignation of the Chateau generals on here.( Good you e-mailed: I was about to write to the Guardian comparing current economists to the self-same Haig and Rawlinson who heroically massacred their own men at the Somme.Did you know that Haig was a member of the Bullingdon Club? Class will out.)
I suppose Jenkins feels that infrastructure spending will not give the immediate boost to popular demand that his other measures like dishing out bank cards worth £1,000 to all and sundry will engender.
Something in that. On the other hand, Silvio Gessell's idea of time limiting the bank credit on a use-it-or-lose-it basis would make sure all the dosh got into the system straight away.

Mike W said...

DBC Reed above,

I did not know Haig was a member of the Bullshit Club at Oxford. Did you know that the most vicious battle the British fought in 1914-15 was the battle Haig engaged in to remove ('degum' as it was called)General Sir John French from command of the BEF. Haig won because he had in Court, a Lady in Waiting, whispering on his side. Not much changes in a hundred years, what, what.

I now own a copy of, 'The Natural Economic Order' by Gessel. Some time ago you and Lola, et al, discussed the matter and I got round to the book ( a swinging 1960s type cover from an Indian printer was my only option). It has no index!

So...
I have had a real job finding secondary sources to read at the same time. But a first scan of the book shows me why Keynes did not discuss Henry George when he approached the topic of Fisher and Gessel in the GT. George is embbeded in Gessel too. Quite satisfactory.

In my hunt around for a good discussion of why Kenyes thought the future belonged to Fisher and Gessel (and George) I came across this Neo Lib economist, who does not seem to be the run of the mill moron. He might amuse you as he seems to me to use the word 'liberal' in the sense of J S Mills, Utilitarianism. Anyway if you dig around he has some interesting stuff about breaking the zero bound.

http://blog.supplysideliberal.com/post/23959666073/what-is-a-supply-side-liberal

Glad to hear your opinion.

DBC Reed said...

@Mike W
Sorry to hear that you were led to read Gesell after a discussion involving me and Lola. Cant imagine what impression you got of this key figure with L going on ,as usual, about "sound money" and minimal government and me going deranged in response, though we always manage to stay polite.
There are plenty of scholars who accuse Keynes of plagiarising Gesell.
My feeling is that he didn't plagiarise him enough: Keynes in the General Theory says that the ideas Gesell derived from Henry George were not very important when, in fact, the Georgist component could have saved the entire "Keynesian" project by taxing or nationalising land to restrain inflation of the money supply.(Somewhere Gesell said that a severe bout of LVT would so knock the stuffing out of land speculators that they would queue up for the compensated land nationalisation Gesell envisaged: would rush to unload their land.)
Most likely, faced with the technological redundancy of having so many robot factories, the chateau generals will have to turn to Gesell and Douglasite national dividend income for all because they will have run out of arguments, as you have said.(My argument with MW is that he would raise the Dividend from Land tax returns when it is simpler for the State to take over the money supply from the banks and issue the dosh straight out with LVT as an anti inflationary back-up.But there is a superstitious belief that banks borrow the dosh off their savers to lend on which is a bit pathological.)