tag:theconversation.com,2011:/ca/topics/dividends-6098/articlesDividends – The Conversation2023-08-09T14:31:04Ztag:theconversation.com,2011:article/2094272023-08-09T14:31:04Z2023-08-09T14:31:04ZInterest rates: the case for cutting them permanently to zero<figure><img src="https://images.theconversation.com/files/541544/original/file-20230807-27-xsmepo.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">shutterstock</span> </figcaption></figure><p>In 1937 the English economist Joan Robinson <a href="https://archive.org/details/dli.ernet.13867/page/n265/mode/2up?view=theater">proposed that</a> “when capitalism is rightly understood, the rate of interest will be set at zero and the major evils of capitalism will disappear”. <a href="https://www.britannica.com/biography/John-Maynard-Keynes">John Maynard Keynes</a>, who had taught Robinson, <a href="https://www.marxists.org/reference/subject/economics/keynes/general-theory/ch16.htm">suggested something</a> similar a year earlier in slightly more qualified and technical terms, arguing that this would be “the most sensible way of gradually getting rid of many of the objectionable features of capitalism”.</p>
<p>Robinson and Keynes were writing during the great depression, when spending and investment were moribund and interest rates seemed like a stranglehold on the economy. Unlike the sort of <a href="https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate#:%7E:text=21%20September%202023-,Official%20Bank%20Rate,-Official%20Bank%20Rate">temporary measure</a> we saw from 2009-21 when rates were close to zero, they believed interest rates should be set at zero permanently as a way to purge capitalism of its most objectionable and destabilising features. </p>
<p>This was a time when the Soviet Union was challenging the western model of prosperity. Indeed, Robinson’s argument was in response to a Marxist, proposing it would lead to “even better results than the revolutionist theory”. </p>
<p>With interest rates rising steeply in the past couple of years and capitalism <a href="https://iea.org.uk/publications/left-turn-aheadsurveying-attitudes-of-young-people-towards-capitalism-and-socialism/">deeply unpopular</a> among younger generations, it is worth returning to this idea. So what was the logic and how would it work?</p>
<h2>The rationale</h2>
<p>Inflation is sustained by consumers, businesses and governments spending in excess of the supply of goods and services. Central banks raise interest rates to reduce demand by discouraging borrowing and spending. This aims to restore equilibrium between supply and demand, and reduces inflationary pressure. </p>
<p>A major problem – setting aside the question of how well it works – is that this distributes the cost of curbing inflation very unevenly. A <a href="https://www.ft.com/content/02f151aa-40a0-4d07-8335-61d02aa6dc4e">recent report</a> by the Royal Bank of Canada said higher interest rates disproportionately hurt poorer and younger people, such as renters and first-time homebuyers. <a href="https://moneyzine.com/uk/resources/debt-statistics-uk/">Anyone borrowing</a> out of financial distress is likely to be in trouble with rising rates. </p>
<p>There are additional objections to positive interest rates. One relates to depleting resources. </p>
<p>Suppose I own a forest that regenerates at 2% per year and is worth £1 million in timber overall. I could log the forest sustainably, cutting down trees only in line with the speed of regeneration, which would earn me £20,000 a year. </p>
<p>But with interest rates at 5.25%, I would do better to cut down everything, invest my £1 million into bonds, and earn upwards of £52,500 in annual interest (I say upwards because the rate of interest on bonds is usually a little way above the central bank base rate). </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Aerial view of a forest" src="https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=449&fit=crop&dpr=1 600w, https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=449&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=449&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=565&fit=crop&dpr=1 754w, https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=565&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=565&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Wooden thinking.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/aerial-top-view-summer-green-trees-1024452661">nblx</a></span>
</figcaption>
</figure>
<p>If the interest rate were zero, it would reduce my incentive to log the entire forest today. It’s true I could still cut it all down and earn a passive income in other ways, such as holding shares that pay good dividends. But that would involve slightly more risk, since dividends are not guaranteed, and the underlying shares might lose value. </p>
<p>In general, to quote a <a href="https://www.theguardian.com/commentisfree/2023/may/06/central-banks-interest-rate-hike-climate-crisis">recent op-ed</a>, central banks raising interest rates make it harder to fight the climate crisis. A permanent zero rate might also discourage wealthy people from parking their money in bonds to earn a passive guaranteed income rather than taking entrepreneurial risks. </p>
<h2>The fiscal alternative</h2>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="JK Galbraith looking pensive" src="https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=798&fit=crop&dpr=1 600w, https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=798&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=798&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1003&fit=crop&dpr=1 754w, https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1003&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1003&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">JK Galbraith.</span>
<span class="attribution"><a class="source" href="https://en.wikipedia.org/wiki/John_Kenneth_Galbraith#/media/File:JK_Galbraith_1962.jpg">Wikimedia</a></span>
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</figure>
<p>If the interest rate were permanently zero, the government’s fiscal levers of taxation and spending would be the alternative means of controlling inflation. The economist John Kenneth Galbraith <a href="https://archive.org/details/economicspublicp0000galb">made the point</a> that using progressive taxes rather than interest rates to control spending would put the greatest costs of maintaining stable prices on those best placed to weather them.</p>
<p>Targeted consumption taxes, for instance on luxury goods or products with an needlessly high carbon footprint, could be used to ensure that the most socially undesirable forms of spending are the first to be reduced during inflation. Likewise, socially desirable forms of spending such as essential infrastructure would be the first to increase during recessions. </p>
<p>Such a system would require several other changes. There would always be a danger that the government would manipulate tax and spending to try and win an election rather than focusing on inflation. This was the main reason independent central banks were given control over interest rates in the first place. </p>
<p>We could prevent that by restricting the inflation-controlling levers to just a few types of tax and spending. We could then give an independent body oversight of these levers to make sure they were not exploited for electoral purposes.</p>
<p>At the same time, there is a risk that permanent zero rates might encourage commercial banks to lend more irresponsibly. There wasn’t a lot of evidence of this <a href="https://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS?locations=GB">in the UK</a> when rates were close to zero in the 2010s. But we did see other economically hazardous activities such as companies borrowing cheaply to buy back their shares to drive up their prices. New regulatory frameworks could be introduced to prevent these kinds of activities. </p>
<p>Giving up control of the interest rate needn’t remove all central-bank control over lending. The “<a href="http://nyborg.ch/book/">open secret of central banks</a>” is that they also control lending through a <a href="https://www.bankofengland.co.uk/markets/eligible-collateral">list of types of loans</a> that they are willing to take as collateral in exchange for providing banks with reserves (in practice these transactions are often indefinitely renewable, so they’re more like purchases).</p>
<p>Banks are strongly motivated to lend to customers according to this framework, since it gives them access to liquidity at low cost. Central banks claim to maintain “neutrality” on the types of loans on these lists, though <a href="https://www.cepweb.org/central-bank-market-neutrality-is-a-myth/">others would disagree</a>. The <a href="https://www.bankofengland.co.uk/-/media/boe/files/markets/eligible-collateral/summary-table-of-collateral.pdf">Bank of England includes</a> mortgages but not construction loans, for instance, encouraging banks to lend more for buying houses than building them. Instead, central banks could openly use these frameworks to <a href="https://www.bloomberg.com/news/articles/2020-10-14/lagarde-says-ecb-needs-to-question-market-neutrality-on-climate">guide banks</a> into making low-risk loans for socially and environmentally responsible ventures. </p>
<h2>The future of central banks</h2>
<p>Also <a href="https://www.bankofengland.co.uk/explainers/what-is-a-central-bank-digital-currency">worth mentioning</a> is the current push by the Bank of England towards <a href="https://www.mckinsey.com/featured-insights/mckinsey-explainers/what-is-central-bank-digital-currency-cbdc">central bank digital currencies</a> (CBDCs), in which buyers and sellers would transfer money directly without having to use the banking system. This could enable central banks to encourage or discourage certain spending in more targeted ways, for example by restricting what can be spent by people in certain areas or income brackets. If inflation was controlled using only fiscal levers, CBDCs could be used to reinforce this policy. </p>
<p>The idea of permanent zero rates is far outside the mainstream of economic thinking. But perhaps Robinson was right to suggest it as a viable compromise between capitalism and more radical alternatives: rewarding entrepreneurship without compounding inequality or incentivising the unsustainable use of resources. At a time like this, it’s an old idea well worth considering.</p><img src="https://counter.theconversation.com/content/209427/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexander Douglas receives funding from the Arts and Humanities Research Council for the Future of Work and Income Research Network (fwirn.co.uk).</span></em></p>Why it’s time to reconsider an idea that was popular with economists during the great depression.Alexander Douglas, Lecturer in Philosophy, University of St AndrewsLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2034412023-04-19T16:57:12Z2023-04-19T16:57:12ZTax optimisation: when the banking sector challenges the spirit of fiscal law<figure><img src="https://images.theconversation.com/files/521612/original/file-20230418-764-d4etsc.jpg?ixlib=rb-1.1.0&rect=0%2C5%2C1908%2C1267&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">According to an investigation by a consortium of journalists, certain tax practices in banks have led to a loss of revenue of 150 billion euros over 15 years in Europe.</span> <span class="attribution"><span class="source">Ken Teegardin/Flickr</span>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span></figcaption></figure><p>On March the 28, 2023, in Paris, the offices of five major banks – <a href="https://www.bloomberg.com/news/articles/2023-03-30/french-banks-said-to-challenge-tax-authorities-after-cum-cum-raids#xj4y7vzkg">BNP Paribas, Société Générale, Natixis, HSBC and Exane (a subsidiary of BNP Paribas)</a>- - were raided as part of preliminary investigations opened in 2021 for suspected tax fraud and tax laundering. These investigations, ordered by the National Financial Prosecutor’s Office (<em>Parquet National Financier</em>), target dividend arbitrage practices widely used by banks: “CumCum” and “CumEx”.</p>
<h2>Dividend arbitrage: what is it?</h2>
<p>Dividend arbitrage is a common tax optimisation technique that benefits foreign shareholders. Just before the dividend payment period, banks temporarily transfer ownership of a client’s shares to another client residing in a <a href="https://www.wsj.com/articles/fed-questions-bank-maneuver-to-reduce-hedge-funds-dividend-taxes-1411952821">low-tax jurisdiction</a>. The bank and the client then share tax savings from the transaction. In France, tax authorities withhold up to 30% tax on dividends paid by companies to foreign shareholders, depending on the tax residence of the shareholder. This strategy makes it possible to reduce – or even completely avoid – French taxes on dividends. Taken to the extreme, it may even allow some foreign shareholders to request refund, from French authorities, of taxes that they did not necessarily pay.</p>
<h2>A legal but potentially abusive tax-optimisation practice</h2>
<p>The <strong>CumCum</strong> technique makes it possible to avoid all or part of the tax levied by France on dividends paid to foreign shareholders by a French company, through two types of financial arrangements.</p>
<ul>
<li><p><strong>Internal</strong>: This involves transferring the shares to a French resident – most often a bank – which collects the dividends before paying them to the foreign investor. Indeed, in some specific situations, banks (as companies) benefit from a more advantageous tax regime than individuals.</p></li>
<li><p><strong>External</strong>: Here, a foreign investor’s shares are transferred to another foreign investor, who could also be a bank, resident in a country with which France has signed a <a href="https://taxsummaries.pwc.com/france/corporate/withholding-taxes">favourable tax treaty</a>.</p></li>
</ul>
<p>Both types of arrangements, in which banks play a key role, allow the investor to make tax savings in exchange of a commission paid to the intermediary (the bank) for the service rendered.</p>
<p>While tax optimisation via CumCum does not necessarily violate the law, its abusive use <a href="https://wwnorton.com/books/Something-for-Nothing/">raises ethical issues</a>. Dispositions were taken in France in 2019 qualifying as abuse of law CumCum transactions having a “mainly” and not only “exclusively” fiscal purpose. Furthermore, France has ratified a multilateral convention developed under the aegis of the OECD, allowing the benefits of tax treaties to be denied when one of the main purposes of the financial arrangement is to obtain an <a href="http://www.senat.fr/compte-rendu-commissions/20211129/fin.html">undue tax advantage</a>. Carrying out a CumCum transaction with an essentially fiscal objective constitutes, at least since 2019, an “abuse of law” that is subject to sanctions.</p>
<h2>CumEx: from potentially abusive to certainly fraudulent</h2>
<p><strong>CumEx</strong> CumEx allows several foreign shareholders to claim tax refunds from the French tax administration (<a href="https://www.senat.fr/rap/r22-072/r22-07219.html">tax that was either never withheld or withheld only once</a>. CumEx is possible because of the high number of exchanges of shares between different individuals shortly before the payment of dividends, making it complicated, if not almost impossible, for the tax administration to identify the “true” owner of the shares. In 2018, the <a href="https://correctiv.org/en/latest-stories/2018/10/18/the-cumex-files/?lang=en">“CumEx Files” investigation</a>, conducted by an international consortium of journalists (including <em>Le Monde</em> and the German daily <em>Die Zeit</em>), exposed the CumCum and CumEx transactions. According to this investigation, the loss of revenue over 15 years for several European countries (including France and Germany) would amount to 150 billion euros. The damage to the French State amounted to 33.4 billion euros. However, given the complexity and multiplicity of the financial arrangements, particularly using short selling, CumEx remains <a href="https://www.tandfonline.com/doi/full/10.1080/00036846.2022.2141450">challenging to prove</a>.</p>
<h2>Between tax optimisation and outright fraud</h2>
<p>While the practice of CumCum is apparently legal, it can be considered borderline from an ethical point of view. Banks defend their use of CumCum transactions by arguing that they strictly comply with the tax rules in force. For Etienne Barel, deputy director general of the French Banking Federation, share lending also meets a real economic need for company financing or financial markets’ fluidity – imposing overly strict rules on French banks would weaken them in the face of their foreign competitors, thus deteriorating the competitiveness of the Paris marketplace.</p>
<p>While we can imagine that <a href="https://wwnorton.com/books/Something-for-Nothing/">dividend arbitrage done ethically</a> could benefit the French economy by allowing quick and easy access to resources and maintaining a certain competitiveness, this does not seem to constitute its <a href="https://www.abebooks.com/9781907444432/Tax-Arbitrage-Trawling-International-System-1907444432/plp">main motivation</a>. In this context, the question becomes how to distinguish what is legal from what is abusive, especially when a financial arrangement is mobilised throughout the year, and more particularly in the periods preceding the dividend payments. Does the government really have the means to distinguish between sales for tax purposes and others? And even if this mechanism is recognised as legal, is it ethical?</p>
<p><a href="https://www.elgaronline.com/display/book/9781800881020/book-part-9781800881020-22.xml">Our research</a> shows that compliance with the rules does not prevent more opportunistic objectives or using the <a href="https://www.researchgate.net/publication/225232587_Linking_Ethics_and_Risk_Management_in_Taxation_Evidence_from_an_Exploratory_Study_in_Ireland_and_the_UK">guise of technical compliance</a> to conceal rather different realities.</p>
<p>In the case of CumEx, the ethical issue is more than obvious because the practice is clearly fraudulent – it’s a straightforward swindle of the tax authorities. Here, the issue is more one of control: CumEx is possible because the speed and the complexity of technological tools, and the number of transactions and tax jurisdictions make it very difficult for the tax administration to identify the real owners of shares. How then to prevent or sanction CumEx? <a href="https://www.cairn-int.info/journal-accounting-auditing-control-2023-1-page-7.htm">Our research shows</a> that the digitisation of trading activities and their increasing complexity have complicated <a href="https://link.springer.com/article/10.1007/s10551-021-04741-3">their control and moral condemnation</a>.</p>
<p>While CumEx is illegal and unethical, banks or tax-optimisation firms may still perceive it as <a href="https://journals.sagepub.com/doi/abs/10.1177/0018726718799404">commonly accepted</a>. Furthermore, the limited aspect of controls raises questions about political will and the means necessary to limit these transactions. <a href="https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7363599/">Research establishes</a> that some technological developments may help to reduce the incidence of financial fraud, but others – such as the anonymity offered by some blockchain applications – will reduce the cost and probably increase the profitability and innovation of fraud.</p><img src="https://counter.theconversation.com/content/203441/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Mouna Hazgui has received funding from the Social Sciences and Humanities Research Council.</span></em></p><p class="fine-print"><em><span>Aziza Laguecir ne travaille pas, ne conseille pas, ne possède pas de parts, ne reçoit pas de fonds d'une organisation qui pourrait tirer profit de cet article, et n'a déclaré aucune autre affiliation que son organisme de recherche.</span></em></p>Five major banks are now in the crosshairs of the French financial prosecutor’s office. Of what are they accused? Here’s the lowdown.Aziza Laguecir, Professeur, EDHEC Business SchoolMouna Hazgui, Associate professor, HEC MontréalLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1996352023-02-10T13:58:48Z2023-02-10T13:58:48ZWhat are stock buybacks, which critics are blaming for hastening Bed Bath & Beyond’s bankruptcy? A finance professor explains<figure><img src="https://images.theconversation.com/files/522689/original/file-20230424-1075-lx31id.jpg?ixlib=rb-1.1.0&rect=175%2C18%2C3850%2C2661&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Bed Bath & Beyond has spent billions in recent years on share buybacks.</span> <span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/BedBathandBeyond/ea8ce516b7be471c88b518eef7cb9ec2/photo?Query=bed%20bath%20&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=117&currentItemNo=8">AP Photo/Ted Shaffrey</a></span></figcaption></figure><p><em>Bed Bath & Beyond <a href="https://www.marketwatch.com/story/bed-bath-beyond-bankruptcy-heres-what-happens-next-7697ed3d">filed for bankruptcy</a> on April 23, 2023, and <a href="https://wolfstreet.com/2023/04/23/after-wasting-11-6-billion-on-share-buybacks-to-return-value-to-shareholders-lol-bed-bath-beyond-goes-bankrupt-will-liquidate/">some analysts</a> <a href="https://news.yahoo.com/bed-bath-beyond-how-stock-buybacks-undermined-the-company-154202427.html">are blaming</a> the billions of dollars the retailer spent on share buybacks as one of the reasons for its downfall. In total, the company has spent nearly US$12 billion buying back its own stock since 2005, including $1 billion in 2021 alone – cash that could have potentially <a href="https://www.therobinreport.com/the-share-buyback-that-killed-bed-bath-beyond/">helped stave off bankruptcy</a>.</em></p>
<p><em>Bed Bath & Beyond is hardly alone in snapping up its own stock. Companies <a href="https://www.bloomberg.com/news/articles/2022-08-18/all-about-stock-buybacks-a-1-trillion-market-force-quicktake?sref=Hjm5biAW">have been buying back</a> record amounts of their own shares in recent years, which prompted President Joe Biden to <a href="https://www.nytimes.com/2023/02/08/us/politics/biden-state-of-the-union-transcript.html">propose quadrupling the tax on buybacks to 4%</a>.</em> </p>
<p><em>But what are stock buybacks, and why do some people consider them to be a bad thing? The Conversation tapped <a href="https://scholar.google.com/citations?user=VxWst50AAAAJ&hl=en&oi=ao">D. Brian Blank</a>, who studies company financial decision-making at Mississippi State University, to fill us in.</em> </p>
<h2>1. What are stock buybacks?</h2>
<p>Before we can answer that question, first we need to understand the basics of how stock works.</p>
<p>Stock <a href="https://www.investor.gov/introduction-investing/investing-basics/investment-products/stocks">represents an ownership interest in a company</a>, such that stockholders have a stake in the business. Companies use stock as one way to <a href="https://hbr.org/1989/11/everything-you-dont-want-to-know-about-raising-capital">raise capital</a> by selling their shares to investors, usually in an <a href="https://theconversation.com/investors-swoon-over-bumbles-ipo-but-what-exactly-is-an-initial-public-offering-155084">initial public offering</a>. </p>
<p>Most stockholders, however, obtain stock by buying it on a secondary market, like the New York Stock Exchange. In this case, <a href="https://thebusinessprofessor.com/en_US/investments-trading-financial-markets/primary-vs-secondary-market-definition">one person chooses to sell their ownership</a> in the company, while another person buys it.</p>
<p>As partial owners, shareholders see the value of their stock rise when the company does well. </p>
<p>One way investors can benefit from holding the stock is that some corporations <a href="https://www.investor.gov/introduction-investing/investing-basics/glossary/dividend">pay dividends</a>, which are payments made directly to shareholders. Another way that stockholders can benefit is by selling the stock for more than they paid for it. Together, this creates a return on investment.</p>
<p>And this brings us to share buybacks – and <a href="https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/how-share-repurchases-boost-earnings-without-improving-returns">why investors like them</a>.</p>
<h2>2. Why do companies buy back their own stock?</h2>
<p>When <a href="https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/us-companies-poised-to-prop-up-eps-with-share-buybacks-in-2023-72955469">companies have extra capital</a>, they might go into the secondary market and buy back stock from investors. This is often referred to as a stock repurchase or <a href="https://hbr.org/2001/04/is-a-share-buyback-right-for-your-company">buyback program</a>. Companies that are older and less focused on rapid growth tend to do them more often. </p>
<p>Companies do this for <a href="https://www.google.com/books/edition/Stock_Buyback_Motivations_and_Consequenc/bclgEAAAQBAJ?hl=en&gbpv=1">a variety of reasons</a>, <a href="https://doi.org/10.1111/j.1745-6622.2000.tb00040.x">such as because</a> they think their shares are undervalued and want to signal optimism to Wall Street, or because they simply want another way to distribute profits to shareholders – <a href="https://corpgov.law.harvard.edu/2018/05/23/why-shareholder-wealth-maximization-despite-other-objectives/">a key goal of any company</a> – <a href="https://doi.org/10.1111/j.1745-6622.2000.tb00040.x">other than through dividends</a>. </p>
<p>Shareholders like buybacks because companies <a href="https://corporatefinanceinstitute.com/resources/accounting/dividend-vs-share-buyback-repurchase/">often pay a premium</a> over market price. And when companies buy their own stock, this removes those shares from the market, which has the effect of lifting share prices as supply goes down, benefiting existing stockholders.</p>
<p>It’s estimated that American companies <a href="https://www.bloomberg.com/news/articles/2023-01-09/corporate-america-is-still-lining-up-to-buy-back-its-own-stock-shares?sref=Hjm5biAW">bought back a record $1 trillion</a> of their own stock in 2022. And Apple is the <a href="https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/us-companies-poised-to-prop-up-eps-with-share-buybacks-in-2023-72955469#:%7E:text=Apple%20Inc.%20is%20the%20biggest,of%20the%20S%26P%20500%20companies.">biggest user of buybacks</a>, having spent $557 billion over the past decade repurchasing its own shares. </p>
<figure class="align-center ">
<img alt="elderly white man with gray hair stands in front of lectern and appears to speak while gesticulating with his hands" src="https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">President Joe Biden said companies should ‘do the right thing’ and stop buying back their own shares.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/BidenOil/e9009d5ff31a4a7792593c5974d1d79f/photo?Query=biden%20union&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=2242&currentItemNo=1">AP Photo/Patrick Semansky</a></span>
</figcaption>
</figure>
<h2>3. Why do Biden and others dislike buybacks?</h2>
<p>Critics like Biden contend that share buybacks represent short-term thinking that doesn’t actually create any real value. They <a href="https://www.wsj.com/articles/biden-to-urge-quadrupling-new-1-tax-on-stock-buybacks-11675723035">argue instead</a> that companies should use more of their profits to invest in more productive activities like business operations, innovation or employees.</p>
<p>Returning money that a company makes to stockholders does mean <a href="https://www.cfo.com/corporate-finance/2021/02/shareholder-distributions-vs-reinvestment-the-gap-grows/">less capital is available</a> for other investments. In his speech, Biden specifically <a href="https://www.nytimes.com/2023/02/08/us/politics/biden-state-of-the-union-transcript.html">called out “Big Oil” companies</a> for using the <a href="https://www.cnbc.com/2023/02/08/big-oil-rakes-in-record-annual-profit-fueling-calls-for-higher-taxes.html">record profits</a> they’ve earned from high energy prices to buy back their stock rather than investing in new wells to increase supply – and <a href="https://www.washingtontimes.com/news/2023/feb/7/biden-rips-outrageous-big-oil-profits-calls-quadru/">help reduce gas prices</a>. </p>
<p>But the decision whether to invest to increase domestic production is a complicated one. For example, the reason companies aren’t investing in new wells right now is not simply because they are buying back stock. The reason has more to do with how oil companies, and their shareholders, don’t think it is profitable to invest in more supply for a <a href="https://www.npr.org/2021/03/06/973649045/hold-that-drill-why-wall-street-wants-energy-companies-to-pump-less-oil-not-more">whole host of reasons</a>, including the global push for greener energy by both policymakers and consumers, which is bound to reduce demand for fossil fuels in the future.</p>
<p>It’s also worth noting that while share repurchases are becoming <a href="https://onlinelibrary.wiley.com/doi/full/10.1111/j.1745-6622.2000.tb00040.x">increasingly common</a> and controversial, they remain very <a href="https://noahpinion.substack.com/p/stock-buybacks-dont-really-matter">similar to dividends</a>, which don’t prompt the same concerns among politicians. </p>
<h2>4. Would increasing the tax result in fewer buybacks?</h2>
<p>The 1% tax on buybacks is actually brand new. </p>
<p><a href="https://www.mayerbrown.com/en/perspectives-events/publications/2023/01/1-stock-buyback-tax-us-treasury-irs-release-interim-guidance">Congress passed the tax</a> in 2022 as part of the Inflation Reduction Act. It took effect at the beginning of 2023 and only affects buyback programs of $1 million or more. </p>
<p>Usually when an activity is taxed, it happens <a href="https://www.americanexperiment.org/tax-something-you-get-less-of-it-policymakers-have-always-known-that/">less frequently</a>. So, I expect the tax to nudge companies to spend less on buybacks and more elsewhere. While politicians intend more of the money to be used to invest in their productive capacity, companies may simply spend more on <a href="https://www.wsj.com/articles/biden-to-urge-quadrupling-new-1-tax-on-stock-buybacks-11675723035">paying shareholders dividends</a>.</p>
<p>Since the tax is new, it’s hard to evaluate its actual impact. <a href="https://www.kiplinger.com/investing/stocks/why-stock-buybacks-could-accelerate-in-q4">Companies reportedly accelerated</a> their repurchase programs in 2022 to avoid paying the tax.</p>
<p>But early data from 2023 suggests the 1% tax isn’t significantly deterring buybacks. <a href="https://www.bloomberg.com/news/articles/2023-02-02/stock-buybacks-hit-132-billion-as-companies-snub-all-warnings?sref=Hjm5biAW">Companies announced $132 billion</a> in buybacks in January, three times as much as a year earlier and the most for the month on record.</p>
<p>Biden’s <a href="https://www.reuters.com/world/us/biden-address-bring-buybacks-billionaire-tax-investor-focus-2023-02-07/">proposal to boost</a> the tax to 4% may alter corporate behavior more. But again, it may just lead to greater dividend payments, not the other types of investments he and others hope for.</p>
<p>In addition, given that Republicans control the House, and Democrats have only a narrow majority in the Senate, this proposal <a href="https://www.cnbc.com/2023/02/07/biden-buyback-tax-isnt-working-in-state-of-the-union-he-wants-more.html">has little chance</a> of becoming law anytime soon.</p>
<p>The reasons why large corporations make the decisions they do about where to allocate capital – whether to build a factory, hire more workers or buy back stock – are complicated and, in my view, never taken lightly. These decisions have many <a href="https://www.google.com/books/edition/Stock_Buyback_Motivations_and_Consequenc/bclgEAAAQBAJ?hl=en&gbpv=1">facets and implications</a>, and are not necessarily bad. I believe this is something worth remembering the next time you hear <a href="https://www.barrons.com/articles/corporate-stock-buyback-tax-51675805358">politicians</a> <a href="https://ca.finance.yahoo.com/news/president-biden-calls-out-stock-buybacks-in-state-of-the-union-address-104810205.html">saying</a> “<a href="https://www.cnn.com/interactive/2023/02/annotated-fact-checked-president-biden-sotu/">corporations should do the right thing</a>.”</p>
<p><em>This is an updated version of an article originally published on Feb. 10, 2023.</em></p><img src="https://counter.theconversation.com/content/199635/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>D. Brian Blank does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The retailer has spent nearly $12 billion buying back its own stock since 2005, money that could have been used to invest in its business.D. Brian Blank, Assistant Professor of Finance, Mississippi State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1782572022-03-06T12:15:17Z2022-03-06T12:15:17ZCorporate taxes can be good for shareholders: Why some actually want their companies to pay tax<figure><img src="https://images.theconversation.com/files/449610/original/file-20220302-13-kbwrv2.jpg?ixlib=rb-1.1.0&rect=0%2C0%2C6240%2C4156&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">When it comes to shareholder credits, shareholders prefer their corporations pay the standard tax they owe — not a lower tax — to ensure higher cash flows.</span> <span class="attribution"><span class="source">(Shutterstock)</span></span></figcaption></figure><p>There is a prevailing assumption that, in the name of profit, shareholders don’t want their corporations to pay taxes. It’s easy to see how less taxes should mean more money in their pockets, but it turns out this is a common, yet understandable, misconception. </p>
<p>Contrary to this belief, shareholders (people who have invested money in a company in exchange for a share of the owndership) sometimes prefer their corporations to pay taxes to maximize cash flows. But, how can that be? Take common news stories about <a href="https://theconversation.com/the-pandora-papers-how-punishing-tax-cheats-can-serve-as-a-deterrent-170435">offshore tax schemes</a>, creative tax planning and <a href="https://www.cbc.ca/radio/day6/episode-363-apple-s-tax-shelters-marvel-vs-dc-london-s-wartime-stretcher-fences-lost-jewish-music-more-1.4391482/how-apple-managed-to-pay-almost-no-tax-on-billions-in-profits-1.4391505">corporations reducing their taxes</a>, for example. These stories all seem to imply that less taxes mean higher cash flows for both corporations and shareholders.</p>
<p>It turns out that isn’t always true. Certain incentives, like shareholder credits that reduce the amount of tax owed on dividends, actually <em>encourage</em> shareholders to prefer their corporations pay the standard tax they owe — not a lower tax — to ensure higher cash flows for themselves.</p>
<h2>A brief overview</h2>
<p>Some countries around the world, such as Australia and Canada, run what’s called an “integrated tax system.” This means that corporate income and individual income are only taxed once, together, as the money makes its way from the corporation to the shareholder. Other countries, like the United States, do not integrate corporate and personal tax, leading to <a href="https://www.investopedia.com/terms/d/double_taxation.asp">double taxation</a> where corporations and individuals end up paying tax twice on the same income. </p>
<p>Let’s take a closer look at why this is important.</p>
<p>Imagine three people: Person A is an employee, Person B runs an unincorporated business and Person C is the sole shareholder of a corporation. Each of these cases generates income of $100,000 for the same type of work. It makes sense that, because the economic activity is the same, taxes at the end of the day are the same. It shouldn’t matter which person you are or how you organize your work life. </p>
<p>But because Person C and their corporation pay taxes separately, that can change which of the three persons you’d prefer to be. To remedy this, we need some way to account for the difference in taxes each person pays. Integrated tax systems are designed to do just that, by ensuring all three individuals are taxed the same amount.</p>
<h2>Integration in action</h2>
<p>Now let’s consider how this works for the shareholder. </p>
<p>Shareholders pay taxes on the dividend payments they receive from a company. Dividend payments are monetary rewards shareholders receive for investing in a company. To accomplish tax integration, shareholders include their proportion of the corporation’s pre-tax income (also known as the dividend) in their individual taxable income as a dividend. The tax is then calculated and shareholders are able to reduce their individual tax liability with credit for taxes the corporation has already paid. </p>
<p>My colleagues and I <a href="https://doi.org/10.2308/accr-52315">developed a numerical illustration</a> to show the incentive this system creates. Shareholders want the corporation to pay taxes and to avoid spending money on <a href="https://www.investopedia.com/terms/t/tax-planning.asp">costly tax planning</a>. The <a href="https://www.penguinrandomhouse.com/books/304634/nudge-by-richard-h-thaler-and-cass-r-sunstein/">valuable tax credits nudge</a> shareholders into wanting their corporations to pay taxes, rather than paying for tax planning to reduce tax — all in the name of greater shareholder after-tax cash flows.</p>
<p>Next, let’s take this illustration into the real world.</p>
<p>In our study, we used a set of European countries that eliminated their integration systems, mostly in the mid-2000s. We compared these “eliminating” countries to other countries that did not change their tax policy and found that getting rid of the credits also got rid of tax incentives. After the change, corporations in these countries engaged in substantially more tax planning to reduce the standard tax they owed. </p>
<figure class="align-center ">
<img alt="A woman walks by the entrance to a building that says 'Cour de Justice de L'union Europeenne' on the front." src="https://images.theconversation.com/files/449931/original/file-20220303-6135-1h3jaqq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/449931/original/file-20220303-6135-1h3jaqq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=387&fit=crop&dpr=1 600w, https://images.theconversation.com/files/449931/original/file-20220303-6135-1h3jaqq.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=387&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/449931/original/file-20220303-6135-1h3jaqq.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=387&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/449931/original/file-20220303-6135-1h3jaqq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=486&fit=crop&dpr=1 754w, https://images.theconversation.com/files/449931/original/file-20220303-6135-1h3jaqq.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=486&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/449931/original/file-20220303-6135-1h3jaqq.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=486&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">A series of rulings by the European Court of Justice in the late 2000s led several countries to eliminate their tax integration systems.</span>
<span class="attribution"><span class="source">(Geert Vanden Wijngaert)</span></span>
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</figure>
<p>Why? In the new tax system without integration, income could be taxed twice as it transferred from corporation to shareholder. So, to maximize shareholder cash flows, the new incentive was to minimize the amount of corporate income that was initially taxed.</p>
<h2>Hold your horses</h2>
<p>Long story short, shareholders can prefer their corporations to pay taxes. But don’t go overboard — no silver bullet exists to kill taxpayers’ inherent preference to minimize taxes. </p>
<p>Our research also showed that other important factors can limit the attractiveness of the shareholder credit incentive. The more a corporation operates in foreign jurisdictions (which do not offer credits), the fewer credits it generates and the more dispersed the shareholders are. This results in a weaker incentive to generate shareholder credits with higher corporate taxes.</p>
<p>In each of these cases, shareholders would rather the corporation minimize its taxes. Nevertheless, an integrated tax system with its shareholder credits might just change the way you, I or governments think about shareholder tax incentives. Typical shareholders want more cash flow, and they’ll do anything — including paying more tax — to get it.</p><img src="https://counter.theconversation.com/content/178257/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andrew Bauer does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Incentives, like shareholder credits for corporate taxes paid, mean that shareholders want their corporations to pay taxes.Andrew Bauer, Assistant professor, Canada Research Chair in Taxation, Governance and Risk, University of WaterlooLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1469152020-09-29T02:15:30Z2020-09-29T02:15:30ZRecord corporate fines don’t deter: here’s a ‘frank’ fix to make penalties bite<p>All things considered, Westpac’s record A$1.3 billion fine for breaching anti-money-laundering laws could have been worse. </p>
<p>Each of the alleged 23 million breaches of the <a href="https://www.legislation.gov.au/Details/C2019C00011">Anti-Money Laundering and Counter-Terrorism Act</a> between 2010 and 2018 carried a penalty of up to A$63,000. So the fine might have been more than A$1 trillion. </p>
<p>The A$1.3 billion equates to three months’ earnings for Westpac. It is A$400 million more than the A$900 million the bank set aside in its half-year results (in April). But that didn’t bother the market. </p>
<p><a href="https://www.asx.com.au/asx/share-price-research/company/WBC/statistics/shares">Westpac’s share price</a> ended the week 7% higher. </p>
<p>As Nathan Zaia, an analyst with investment research company Morningstar, <a href="https://www.smh.com.au/business/banking-and-finance/westpac-announces-record-breaking-1-3b-fine-20200924-p55yno.html">explained</a>: “It’s huge. It’s the largest fine in history. It’s an eye-watering number. But it’s already pretty much been expected by the market.”</p>
<p>With Westpac’s annual profit exceeding A$6 billion, and its market capitalisation more than A$60 billion, Zaia said a few hundred million dollars more didn’t “really have much of an impact with the valuation we put on the bank”.</p>
<p>If the biggest fine in Australian corporate history doesn’t make a difference to a company’s share price, it’s hard to see how that fine serves as a deterrent. It is the job of the board and senior management to serve the interests of shareholders. What doesn’t matter to investors won’t matter much to the board either.</p>
<p>There could be a way, though, to use the tax system to give corporate fines more bite, by making shareholders feel more of the pain.</p>
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<strong>
Read more:
<a href="https://theconversation.com/how-westpac-is-alleged-to-have-broken-anti-money-laundering-laws-23-million-times-127518">How Westpac is alleged to have broken anti-money laundering laws 23 million times</a>
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<h2>What franking credits do</h2>
<p>Franking credits – also known as <a href="https://theconversation.com/words-that-matter-whats-a-franking-credit-whats-dividend-imputation-and-whats-retiree-tax-111423">dividend imputation payments</a> – are tax credits provided to shareholders with their dividend payments. </p>
<p>The credits are intended to ensure income from investment is not taxed twice – first by the company paying tax on its profit, then by the shareholder paying income tax on their share of that profit (their dividend).</p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/words-that-matter-whats-a-franking-credit-whats-dividend-imputation-and-whats-retiree-tax-111423">Words that matter. What’s a franking credit? What’s dividend imputation? And what's 'retiree tax'?</a>
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<p>Franking credits on dividends allow shareholders to cut their tax bills by the tax already paid on the dividend income they receive.</p>
<p>In some cases, thanks to a provision in Australia’s law, where the shareholder pays no overall tax, they can receive a tax refund from the government, a <a href="https://theconversation.com/words-that-matter-whats-a-franking-credit-whats-dividend-imputation-and-whats-retiree-tax-111423">dividend imputation cheque</a>, of the kind Labor promised to wind back in the 2019 election campaign. </p>
<h2>Franking debits as penalty</h2>
<p>There already exists a mechanism to use the imputation system to penalise bad behaviour by companies.</p>
<p>Where a company has not followed the rules relating to franking credits, the tax office can debit the company’s franking account, leaving less to distribute to shareholders as tax credits. </p>
<p>A similar mechanism could be used to impose fines. Instead of the company writing a cheque, the government would debit the value of the fine from the bank’s franking account.</p>
<p>This would directly affect the bank’s capacity to “impute” tax it has paid on profits. </p>
<p>Though the same amount of money imposed as a fine might have little impact on a company’s operations or profits, the loss of franking credits is something shareholders are likely to notice. </p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/westpac-ticking-every-anti-money-laundering-box-wouldnt-make-much-difference-to-criminals-127988">Westpac ticking every anti-money-laundering box wouldn't make much difference to criminals</a>
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<p>And if shareholders care, the directors might get the message louder and clearer.</p><img src="https://counter.theconversation.com/content/146915/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Michael William Blissenden does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Rather than imposing a straight fine, taking away franking credits would ensure shareholders feel more pain when companies misbehave.Michael William Blissenden, Professor of Law, University of New EnglandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1460422020-09-13T15:34:23Z2020-09-13T15:34:23ZClearing up a common misconception: shareholders do not get rich off dividends<p>On March 24, France’s minister of the economy and finance, Bruno Le Maire, urged the country’s firms to exercise the utmost restraint in paying dividends in 2020 and stated that companies in which the state is a shareholder would be asked not to pay dividends, at least not to private individuals, adding that sharing value is also an act of solidarity.</p>
<p>The government can legitimately urge or even compel companies to restrict or freeze dividend payments on the grounds of solidarity if these companies receive financial aid from the State. There is nothing unusual about governments imposing certain conditions before providing financial aid (although the pertinence of these conditions is debatable). Companies are free to choose whether they wish to benefit from a rescue package or not; if they do, as a trade-off they must agree not to pay dividends.</p>
<p>However, private companies that consider they have sufficient cash flow to pay dividends, such as Hermès or Total, are absolutely free to do so. It is up to the company and its shareholders to decide whether or not they wish to use their capital as an instrument of solidarity.</p>
<p>Moreover, withholding dividends is not the only way to show support. Total, for example, chose to provide 50 million euros of <a href="https://www.total.com/media/news/press-releases/covid-19-total-mobilized-support-hospital-healthcare-staff-france-providing-them-50-million-euros">fuel vouchers</a> to health workers.</p>
<p>The current crisis situation is especially conducive to heated debates about dividend payments. It would seem that a closer look at the financial theory is necessary to clarify certain points, particularly the following: a dividend distribution does not mean that the shareholders are systematically getting rich.</p>
<h2>Dividends are neutral for the shareholder</h2>
<p>Shareholders own a share of the company that is proportionate to the amount they invested in its capital. They bear all the risks (<a href="https://www.investopedia.com/terms/b/bankruptcyrisk.asp">risk of bankruptcy</a>, <a href="https://www.investopedia.com/terms/l/liquidityrisk.asp">liquidity risk</a> or <a href="https://www.lafinancepourtous.com/decryptages/marches-financiers/produits-financiers/actions-2/les-risques-associes-aux-actions/le-risque-de-perte-en-capital/">risk of capital loss</a>), in exchange for which they hope to obtain a return on their stocks and be paid dividends (as cash or stock) as the fruit of their investment.</p>
<p>One month after the crisis began, the benchmark index for French stocks, the <a href="https://en.wikipedia.org/wiki/CAC_40">CAC 40</a>, had lost <a href="https://www.latribune.fr/bourse/39-en-un-mois-le-plongeon-historique-du-cac-40-en-six-dates-842529.html">39% of its value</a>, which corresponds to the average loss suffered by shareholders. When you consider the losses suffered across all stock exchanges, a dividend payout seems symbolic.</p>
<p>Financial theory tells us that if the goal of a shareholder is to maximise their wealth, then whether a dividend is paid or not is of no importance. Indeed, all other things being equal, the price of the stock is reduced by the amount of the dividend paid.</p>
<p>If this were not the case, there would inevitably be an arbitrage: investors would buy shares that they anticipate are about to pay a dividend and then sell them right after. It would then be possible to make money without taking any risks. But any insider knows that there is no such thing as a free meal in the financial markets, otherwise they would not be efficient.</p>
<p>As the figures below show, shareholder wealth is not contingent upon dividend payouts.</p>
<figure class="align-center ">
<img alt="Stock price following a dividend payment in the case of a prior appreciation." src="https://images.theconversation.com/files/357679/original/file-20200911-14-13xsm7u.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/357679/original/file-20200911-14-13xsm7u.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=261&fit=crop&dpr=1 600w, https://images.theconversation.com/files/357679/original/file-20200911-14-13xsm7u.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=261&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/357679/original/file-20200911-14-13xsm7u.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=261&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/357679/original/file-20200911-14-13xsm7u.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=328&fit=crop&dpr=1 754w, https://images.theconversation.com/files/357679/original/file-20200911-14-13xsm7u.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=328&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/357679/original/file-20200911-14-13xsm7u.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=328&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Figure 1a: Stock price following a dividend payment in the case of a prior appreciation.</span>
</figcaption>
</figure>
<p>If no dividend is paid, the shareholder’s entire wealth is concentrated in the value of their shares. If a dividend is paid, their wealth is split between the dividend and the new value of the security.</p>
<p>The same is true whether the stock price appreciated (Figure 1a) or depreciated (Figure 1b).</p>
<figure class="align-center ">
<img alt="Stock price following a dividend payment in the case of a prior depreciation." src="https://images.theconversation.com/files/357680/original/file-20200911-16-14tgqga.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/357680/original/file-20200911-16-14tgqga.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=275&fit=crop&dpr=1 600w, https://images.theconversation.com/files/357680/original/file-20200911-16-14tgqga.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=275&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/357680/original/file-20200911-16-14tgqga.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=275&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/357680/original/file-20200911-16-14tgqga.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=345&fit=crop&dpr=1 754w, https://images.theconversation.com/files/357680/original/file-20200911-16-14tgqga.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=345&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/357680/original/file-20200911-16-14tgqga.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=345&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Figure 1b: Stock price following a dividend payment in the case of a prior depreciation.</span>
</figcaption>
</figure>
<p>In the case of publicly-traded companies, if the dividend is paid as stock, the total wealth of the shareholder <a href="https://theconversation.com/dividendes-et-rachats-dactions-nenrichissent-pas-les-actionnaires-56562">does not change either</a>. The total value of the shareholder’s shares is then spread across a greater number of shares.</p>
<h2>So what is the point of dividends?</h2>
<p>Although dividends do not maximise wealth, shareholders are still very attached to them. There are <a href="https://www.sciencedirect.com/science/article/abs/pii/0304405X84900254">three psychological reasons</a> for this.</p>
<p><strong>The theory of perspectives</strong>: if there is a gain (Figure 1a), the dividend payment is more highly valued because, <a href="https://www.andlil.com/theorie-des-perspectives-153648.html">psychologically</a>, the shareholder feels like they have made gains on two levels and they value each separately. Opening gifts that are wrapped individually always bring more satisfaction than when they are all wrapped together as a single gift.</p>
<p>If there is a loss (Figure 1b), a dividend remains the preference. Psychologically, it is regarded positively and seen as separate from the drop in value. A 12-euro drop followed by a 2-euro rise seems less of a bitter pill to swallow than a single loss of 10 euros.</p>
<p><strong>Mental accounting</strong>: <a href="https://www.investopedia.com/terms/m/mentalaccounting.asp">mental accounting</a> can be defined as a set of cognitive processes we use to organise, evaluate and process financial problems. We treat our income differently depending on its source. This gives rise to certain rules that help us to keep ourselves in check, such as “spend revenue from capital but don’t touch the capital”. Indeed, it is quite common to use our regular income to pay for our everyday expenses and to allocate our “bonus” income to recreational spending or luxury items.</p>
<p><strong>Regret aversion</strong>: for the shareholder, receiving a dividend is a way to make money without having to make the decision to sell their shares. If they were compelled to sell their shares for liquidity reasons, their <a href="https://www.letemps.ch/economie/produits-structures-theorie-regret-lacte-dinvestir">feeling of regret</a> would be all the more intense if the value of the stock were to later rise. Regret even more keenly felt for not having reinvested the dividend. Regret by omission is always less unpleasant than regret by commission!</p>
<p>To get back to the global crisis that is currently our biggest concern, it is also worth mentioning also that dividends and economic recovery are not incompatible. From the point of view of the economy as a whole, dividend payments or share buybacks by companies are a way to redistribute some money to shareholders that can then be reinvested in other companies with <a href="https://www.lesechos.fr/idees-debats/cercle/dividendes-et-enrichissement-des-actionnaires-attention-aux-amalgames-132904">better growth prospects</a>.</p>
<p>Shareholders can reinvest this money in growing companies that need funds to expand, and in so doing contribute to developing the economy. Dividend payouts are therefore one of the basic mechanisms that enable market economies to function efficiently.</p>
<hr>
<p><em>This article was <a href="https://knowledge.skema.edu/to-clear-up-a-common-misconception-shareholders-do-not-get-rich-off-dividends/">translated by SKEMA Business School</a> from the French original.</em></p><img src="https://counter.theconversation.com/content/146042/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Les auteurs ne travaillent pas, ne conseillent pas, ne possèdent pas de parts, ne reçoivent pas de fonds d'une organisation qui pourrait tirer profit de cet article, et n'ont déclaré aucune autre affiliation que leur organisme de recherche.</span></em></p>Financial theory shows that the dividend is economically neutral, although it helps to reassure the shareholder psychologically.Sabrina Chikh, PhD, Professeur Associé, SKEMA Business SchoolPascal Grandin, Professeur, Université de LilleLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1442892020-08-13T20:10:31Z2020-08-13T20:10:31ZFor some companies, JobKeeper has become DividendKeeper. They are paying out, even though the future looks awful<figure><img src="https://images.theconversation.com/files/352642/original/file-20200813-22-lrfvhs.jpg?ixlib=rb-1.1.0&rect=157%2C151%2C2791%2C1461&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">RomanR/Shutterstock</span></span></figcaption></figure><p>In this recession, unlike in previous ones, governments have chosen to help pay salaries to keep workers in work rather than pay unemployment benefits when they laid off.</p>
<p>It means that the July unemployment rate revealed on Thursday was <a href="https://www.abs.gov.au/ausstats/abs@.nsf/mf/6202.0">7.5%</a> instead of the <a href="https://www.abs.gov.au/ausstats/abs@.nsf/Latestproducts/6202.0Main%20Features10Jul%202020">8.3%</a> it would have been had those working zero hours but being paid by JobKeeper been counted as out of work.</p>
<p>This approach has kept employees and firms ready for work at a time when it is far from clear when things will improve.</p>
<p>Implicit in the deal was that firms in need of JobKeeper would behave as if they were in times of immense uncertainty and not pay big dividends to shareholders on the assumption that things were rosy.</p>
<p>It is early in the company reporting season but already <a href="https://www.theguardian.com/australia-news/2020/aug/12/the-dividendkeeper-shuffle-how-jobkeeper-payments-are-flowing-to-shareholders">there are signs</a> that millions of dollars in increased dividends are being paid out by companies that received <a href="https://www.afr.com/politics/federal/jobkeeper-becomes-dividendkeeper-20200810-p55kc0">millions of dollars of JobKeeper</a>.</p>
<p>As The Guardian’s Ben Butler puts it</p>
<blockquote>
<p>what we are seeing is a transfer of millions of dollars from taxpayers – the community at large – to shareholders, some of whom are already quite rich</p>
</blockquote>
<p>By supporting the wages of employees in companies at risk, the government freed up money the companies could use to pay shareholders increased dividends rather than fortify themselves against that risk.</p>
<p>It enabled them to shovel out of the door the money the government was shovelling in, leaving themselves no better prepared than before.</p>
<p>And they need to be prepared.</p>
<h2>The last thing we need is big dividends</h2>
<p>In April the <a href="https://theconversation.com/the-last-thing-companies-should-be-doing-right-now-is-paying-dividends-135928">Australian Prudential Regulation Authority</a> wrote to banks and insurers asking them to “seriously consider deferring decisions on the appropriate level of dividends until the outlook is clearer”. </p>
<p>Even where they were confident they had the resources they needed, their dividends should be at a “materially reduced level”.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/352654/original/file-20200813-20-eqtc60.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/352654/original/file-20200813-20-eqtc60.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/352654/original/file-20200813-20-eqtc60.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=971&fit=crop&dpr=1 600w, https://images.theconversation.com/files/352654/original/file-20200813-20-eqtc60.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=971&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/352654/original/file-20200813-20-eqtc60.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=971&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/352654/original/file-20200813-20-eqtc60.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1220&fit=crop&dpr=1 754w, https://images.theconversation.com/files/352654/original/file-20200813-20-eqtc60.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1220&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/352654/original/file-20200813-20-eqtc60.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1220&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Commonwealth Bank Chief Matt Comyn. Maximum dividend, but outlook highly uncertain.</span>
</figcaption>
</figure>
<p>Perhaps precipitously, it relaxed the guidance on <a href="https://www.apra.gov.au/news-and-publications/apra-updates-guidance-on-capital-management-for-banks-and-insurers">July 29</a>, noting that uncertainty had “reduced somewhat”. A few days later Melbourne went into Stage 4 lockdown.</p>
<p>Its new guideline was for banks to retain at least half of their earnings when making decisions on dividends, an instruction the Commonwealth Bank followed to the letter on Wednesday paying out <a href="https://www.afr.com/chanticleer/cbas-dividend-shows-its-strength-and-power-20200812-p55kwp">49.95%</a> of its earnings as dividends.</p>
<p>That night on ABC’s The Business the bank’s chief executive Matt Comyn conceded the outlook was “<a href="https://www.abc.net.au/news/programs/the-business/">highly uncertain</a>”.</p>
<p>Earlier that day we learnt that the private sector wage index had stopped for the first time in its 27 year history.</p>
<p>A graph presented to Commonwealth Bank shareholders on Wednesday shows that almost all of the increase in deposits in its accounts comes from government benefits rather than wages and salaries.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/352666/original/file-20200813-24-hllli0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/352666/original/file-20200813-24-hllli0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/352666/original/file-20200813-24-hllli0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=293&fit=crop&dpr=1 600w, https://images.theconversation.com/files/352666/original/file-20200813-24-hllli0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=293&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/352666/original/file-20200813-24-hllli0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=293&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/352666/original/file-20200813-24-hllli0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=368&fit=crop&dpr=1 754w, https://images.theconversation.com/files/352666/original/file-20200813-24-hllli0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=368&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/352666/original/file-20200813-24-hllli0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=368&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.asx.com.au/asxpdf/20200812/pdf/44ldwmfm9dfd04.pdf">Commonwealth Bank results presentation</a></span>
</figcaption>
</figure>
<p><a href="https://www.apra.gov.au/temporary-loan-repayment-deferrals-due-to-covid-19-june-2020">Some 10%</a> of all bank loan books are now made up of loans on which borrowers have been granted deferred payments. </p>
<p>Among small businesses, 17% of repayments have been deferred, a proportion set to climb from September as Job keeper subsidies are <a href="https://theconversation.com/bowing-out-gracefully-how-theyll-wind-down-and-better-target-jobkeeper-143011">reduced and withdrawn</a>.</p>
<p>In March the government gave companies temporary relief from rules that prevent them from <a href="https://treasury.gov.au/sites/default/files/2020-03/Fact_sheet-Providing_temporary_relief_for_financially_distressed_businesses.pdf">trading while insolvent</a>. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/the-last-thing-companies-should-be-doing-right-now-is-paying-dividends-135928">The last thing companies should be doing right now is paying dividends</a>
</strong>
</em>
</p>
<hr>
<p>For the moment the change has pushed insolvencies down to an <a href="https://www.theaustralian.com.au/business/leadership/calls-for-urgent-reform-of-insolvency-process/news-story/395f98059ac3cf1ee1acf113990bc3d5">all time low</a>, creating an unknown amount of zombie companies not fully alive but <a href="https://www.afr.com/policy/economy/creditors-in-danger-of-repayment-demands-from-rash-of-insolvencies-20200728-p55g48">not yet dead</a>.</p>
<p>When the temporary relief expires (September, unless it is extended) there’s talk of an <a href="https://www.theaustralian.com.au/business/financial-services/plans-needed-to-avert-insolvency-tidal-wave/news-story/a10c5058d51441bb5aed7bcf8c2c8fd7">tidal wave</a> of insolvencies.</p>
<p>It raises concerns that for now many companies are announcing dividends that shouldn’t and ordinarily wouldn’t be paid. </p>
<p>Some (not the Commonwealth Bank) are using JobKeeper to pay them.</p>
<h2>Why dividends, now of all times?</h2>
<p>There is a relationship between dividends, share prices and executive pay. Australian companies that pay out big dividends keep their share prices high. </p>
<p>Many Australians receiving <a href="https://theconversation.com/words-that-matter-whats-a-franking-credit-whats-dividend-imputation-and-whats-retiree-tax-111423">dividend imputation</a> cheques, including many retirees, hold shares because of them.</p>
<p>Without them, share prices would fall and executives would be denied their bonuses.</p>
<p>One way to ensure that there is money available for dividends is to rule out new investments that can’t achieve a high rate of return, meaning money can be paid out to shareholders instead.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/high-hurdle-rates-are-holding-back-businesses-but-perhaps-they-should-be-129435">High hurdle rates are holding back businesses, but perhaps they should be</a>
</strong>
</em>
</p>
<hr>
<p>Reserve Bank Governor <a href="https://www.rba.gov.au/speeches/2019/sp-gov-2019-10-29.html">Philip Lowe</a> has complained that hurdle rates of 13% to 14% seem to be “hard-wired into the corporate culture in some companies” notwithstanding the record low rates at which they can obtain funds.</p>
<p>In January the head of the Australian Competition and Consumer Commission <a href="https://www.afr.com/policy/economy/business-slams-accc-over-calls-to-lower-hurdle-rates-20200103-p53oj0">Rod Sims</a> warned that unless companies lowered their hurdle rates they would “risk missing investment opportunities to foreign raiders”.</p>
<p>It’s something akin to an undeclared investment strike by corporate Australia, something akin to “heads, shareholders win; tails, employee, creditors and the rest of us lose”.</p><img src="https://counter.theconversation.com/content/144289/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andrew Linden received funding from RMITs EU Centre to conduct his doctoral research. The Centre is funded by the European Union</span></em></p><p class="fine-print"><em><span>Warren Staples has received funding from Australia China Council, Department of Foreign Affairs and Trade (DFAT), and the Victorian Managed Insurance Authority (VMIA). Warren is currently a member of the Institute of Public Administration Australia (IPAA) Victoria’s Sustainability Community of Practice (CoP) Advisory Committee.</span></em></p>Wages are going backwards, loans are in arrears, companies are being kept alive by government support and an exemption from insolvency rules, yet still they are paying out dividends.Andrew Linden, Sessional Lecturer, PhD (Management) Candidate, School of Management, RMIT UniversityWarren Staples, Senior Lecturer in Management, RMIT UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1378892020-05-06T19:50:21Z2020-05-06T19:50:21ZBank dividends are bare. Here’s why some shareholders hate it more than they should<p>In bad news for retirees and others who depend on dividend cheques (and dividend imputation rebate cheques from the Tax Office) bank dividends have largely evaporated. But it’s not as bad as many commentators suggest, and actually good for some investors.</p>
<p><a href="https://www.westpac.com.au/content/dam/public/wbc/documents/pdf/aw/ic/2020_Interim_Media_Release.pdf">Westpac</a> won’t be paying a dividend this half year. Nor will the <a href="https://yourir.info/resources/4d216b570d08af30/announcements/anz.asx/3A540286/ANZ_News_Release_ANZ_NZ_2020_half-year_result.pdf">ANZ</a>, nor the <a href="https://wcsecure.weblink.com.au/pdf/BOQ/02224752.pdf">Bank of Queensland</a>.</p>
<p>The <a href="https://www.nab.com.au/about-us/shareholder-centre/dividend-information">National Australia Bank</a> will pay one, but only a third the usual size. The Commonwealth Bank’s different reporting dates mean it won’t have to make a decision <a href="https://www.commbank.com.au/about-us/investors/dividend-information.html">until August</a>.</p>
<p>The Financial Review believes the moves have taken <a href="https://www.afr.com/companies/financial-services/westpac-shareholders-have-long-wait-ahead-on-dividends-20200504-p54plj">A$9.8 billion</a> in expected dividends and <a href="https://theconversation.com/deeming-rates-explained-what-is-deeming-how-does-it-cut-pensions-and-why-do-we-have-it-120089">franking credits</a> from bank shareholders to date. </p>
<p>The flip-side missed by many commentators and shareholders is that bank shares are worth more (maybe around $9.8 billion more) than if they had paid those dividends.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=840&fit=crop&dpr=1 600w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=840&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=840&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1056&fit=crop&dpr=1 754w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1056&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1056&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.apra.gov.au/sites/default/files/2020-04/Capital%20management.pdf">APRA letter to financial institutions, April 7, 2020</a></span>
</figcaption>
</figure>
<p>As it happens, the decisions follow pressure from the Prudential Regulation Authority which last month sent banks an <a href="https://www.apra.gov.au/capital-management">unprecedented letter</a> asking them to “seriously consider deferring decisions on the appropriate level of dividends”.</p>
<p>It isn’t what bank shareholders have come to expect. </p>
<p>The Commonwealth Bank’s <a href="https://www.commbank.com.au/about-us/investors/dividend-information.html">dividend policy</a> says it will aim to pay cash dividends at “strong and sustainable levels”, maximising dividend imputation cheques from the government by paying <a href="https://theconversation.com/deeming-rates-explained-what-is-deeming-how-does-it-cut-pensions-and-why-do-we-have-it-120089">fully franked</a> dividends.</p>
<p>The dividend reductions come after sharp collapses in share prices brought about by hits to current and expected future earnings and increased economic uncertainty.</p>
<p>But, as hard as it is to look beyond dividends, imputation cheques and the price of shares, what’s most important for the owners of shares are the earnings prospects for the banks long term. And here, as hard as it might be for some shareholders to accept, the suspension of dividends is a sensible strategy for the banks.</p>
<h2>Cruel to be kind makes sense for banks</h2>
<p>In making decisions about dividends in the wake of bad news, each bank had two options. </p>
<p>One was to keep paying dividends at previous levels. </p>
<p>That would have pushed the share price down further, as evidenced by the typical drop in a company’s share price after dividends have been paid. </p>
<p>With the funds paid out as dividends, and no longer part of the bank’s shareholders funds, each share becomes correspondingly worth less. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/the-last-thing-companies-should-be-doing-right-now-is-paying-dividends-135928">The last thing companies should be doing right now is paying dividends</a>
</strong>
</em>
</p>
<hr>
<p>It also puts the bank in a weaker position to weather unexpected loan losses if the COVID-19 storm turns out to be even worse than expected. </p>
<p>The other option was to scrap (or reduce) its dividend and avoid the ex-dividend date drop in its share price. It bolsters its capital strength and gives shareholders higher expected capital gains (or lower capital losses).</p>
<p>Broadly, the loss of dividends should be offset to some degree by a higher share price and higher capital gains. </p>
<p>But try telling shareholders that the dividends they have lost can be replaced by selling shares.</p>
<h2>Tax makes retirees hate it</h2>
<p>That they care is in part psychological. Shareholders view a bird (dividend) in the hand as better than one (a capital gain) in the bush. </p>
<p>Selling shares is seen as “dipping into one’s capital”, even though it has the same effect on the shareholder’s capital (the value of shares held) as taking a dividend.</p>
<p>Another reason shareholders care more than you might think is tax. </p>
<p>Typically (based on historical evidence) a franked dividend of $1 leads to a share price fall of around $1. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/deeming-rates-explained-what-is-deeming-how-does-it-cut-pensions-and-why-do-we-have-it-120089">Deeming rates explained. What is deeming, how does it cut pensions, and why do we have it?</a>
</strong>
</em>
</p>
<hr>
<p>But for an investor on a zero tax rate (as many retirees are) that $1 dividend is actually worth around $1.43. </p>
<p>This is because the Tax Office rebates that investor <a href="https://www.marketindex.com.au/franking-credits">43 cents</a> of tax previously paid by the bank, a so-called dividend imputation payment. </p>
<p>Selling $1.43 of shares to compensate for the lost dividend cash flow leaves them worse off.</p>
<p>Super funds on a low 15% tax rate are also likely to prefer payment of franked dividends since they can use the imputation credits to reduce tax on other investment income.</p>
<h2>Tax makes other shareholders like it</h2>
<p>High tax rate investors and foreign shareholders think quite differently. </p>
<p>For high tax rate investors, Australia’s practice of taxing only <a href="https://www.realestate.com.au/advice/what-is-capital-gains-tax/">half</a> of each capital gain can make the higher capital gains associated with higher share prices more attractive than receiving dividends on which they have to pay extra tax.</p>
<p>Foreign shareholders also generally prefer capital gains to franked dividends, since they can’t use Australia’s imputation credits.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/heres-a-radical-reform-that-could-pay-every-retiree-the-full-pension-131289">Here's a radical reform that could pay every retiree the full pension</a>
</strong>
</em>
</p>
<hr>
<p>Under any tax system where dividends and capital gains are taxed differently, deferring dividends hurts some investors and benefits others. Australia’s imputation tax system magnifies that effect, with low tax rate investors being losers.</p>
<p>As it happens, these features of the tax system took centre stage in last year’s election, in which Labor proposals to change both the rules regarding dividend imputation and capital gains were <a href="https://theconversation.com/going-up-monday-showed-what-the-market-thinks-of-morrison-117396">rejected</a> by voters.</p>
<h2>Longer term, investors might thank banks</h2>
<p>The root cause of the hit to dividends is uncertainty about the future. </p>
<p>If economic conditions turn out worse than expected, banks will find themselves hesitant to make loans unless they have sufficient capital to absorb unexpected losses.</p>
<p>To the extent that they use that capital to help restore the health of the economy, all investors (including those reliant on future dividends) will be better off.</p><img src="https://counter.theconversation.com/content/137889/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kevin Davis does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Westpac and the ANZ have suspended dividends payments. The National Australia Bank has slashed them. The peculiarities of our tax system explain why retirees hate this more than they should.Kevin Davis, Professor of Finance, The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1364072020-04-16T19:36:08Z2020-04-16T19:36:08ZVital Signs: APRA’s extraordinary gift to banks under pressure to pay dividends<figure><img src="https://images.theconversation.com/files/328313/original/file-20200416-192715-tkuwie.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>Last week the Australian Prudential Regulation Authority (APRA) sent an <a href="https://www.apra.gov.au/capital-management">extraordinary letter</a> to Australia’s banks and insurers, essentially telling them to cut their dividend payments to shareholders in light of the coronavirus crisis.</p>
<p>It said it expected banks and insurers to “seriously consider deferring decisions on the appropriate level of dividends”.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=840&fit=crop&dpr=1 600w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=840&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=840&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1056&fit=crop&dpr=1 754w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1056&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1056&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.apra.gov.au/sites/default/files/2020-04/Capital%20management.pdf">APRA letter to financial institutions, April 7, 2020</a></span>
</figcaption>
</figure>
<p>Where a board was confident that it could approve a dividend on the basis of robust stress testing that had been discussed with APRA, it should “nevertheless be at a materially reduced level”. </p>
<p>Where dividends were paid those payments should be “offset to the extent possible through the use of dividend reinvestment plans and other capital management initiatives”. </p>
<p>With Australia’s big four banks potentially suffering big losses due to mortgage defaults among other things, their capital bases are at risk.</p>
<p>Equity research analysts at <a href="https://www.nytimes.com/reuters/2020/04/08/world/asia/08reuters-health-coronavirus-australia-banks.html">Macquarie</a> outline a scenario under which bank losses</p>
<blockquote>
<p>reach A$25-27 billion per bank, and their capacity to pay dividends (without raising equity) materially diminishes</p>
</blockquote>
<h2>Why did APRA do it?</h2>
<p>The letter isn’t a “ban” on dividends, and APRA wasn’t telling the banks anything they don’t already know. So why did it bother?</p>
<p>The answer lies in the economics of how investors react to firms that don’t pay the dividends expected.</p>
<p>Seen through that lens, APRA was very clever indeed.</p>
<p>In a classic 1985 paper <a href="https://onlinelibrary.wiley.com/doi/epdf/10.1111/j.1540-6261.1985.tb02362.x">Merton Miller and Kevin Rock</a> provided a theoretical answer to the puzzle of why paying dividends seems to signal good news to investors, and why cutting dividends seems to signal bad news, and cuts the share price.</p>
<p>In the Miller-Rock model, the managers of a firm have better information about its future prospects than outside investors. </p>
<p>To keep it simple, imagine there are two “types” of firms: good and bad. </p>
<p>Good firms have high future cashflows, bad ones have low ones.</p>
<p>Only the managers know which is which.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/the-last-thing-companies-should-be-doing-right-now-is-paying-dividends-135928">The last thing companies should be doing right now is paying dividends</a>
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</em>
</p>
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<p>Because both types of firm can earn something from investing in the business, it is in the interest of both (more so the good firm) to invest rather than pay out dividends.</p>
<p>Miller and Rock wondered whether what each type of firm did provided clues to investors about whether the managers thought it was good or bad.</p>
<p>Surprisingly, they found that usually good firms will pay high dividend and bad firms no dividends. </p>
<p>It is surprising because good firms are sacrificing more by paying dividends.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/australias-appetite-for-dividends-could-cannibalise-economic-growth-46403">Australia's appetite for dividends could cannibalise economic growth</a>
</strong>
</em>
</p>
<hr>
<p>Their logic was that the bad firms were the least able to afford good dividends and that good firms knew this and paid high dividends to signal they could afford to. </p>
<p>It has a striking implication with <a href="https://www.nber.org/papers/w4244">strong empirical support</a>. </p>
<p>If a firm gets a temporary negative shock to its cashflow or investment prospects it won’t want to cut its dividend lest investors think it has turned “bad”.</p>
<p>It will borrow or even do short-term damage to its prospects in order to maintain investor confidence and hence a high stock price.</p>
<h2>Get out of jail free</h2>
<p>Notice that the signalling theory of dividends implies that the managers of firms would like to cut dividends in tough financial times, and probably should, but they worry about sending a bad signal to investors.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/328304/original/file-20200416-192698-pj1hzp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/328304/original/file-20200416-192698-pj1hzp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/328304/original/file-20200416-192698-pj1hzp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=971&fit=crop&dpr=1 600w, https://images.theconversation.com/files/328304/original/file-20200416-192698-pj1hzp.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=971&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/328304/original/file-20200416-192698-pj1hzp.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=971&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/328304/original/file-20200416-192698-pj1hzp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1220&fit=crop&dpr=1 754w, https://images.theconversation.com/files/328304/original/file-20200416-192698-pj1hzp.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1220&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/328304/original/file-20200416-192698-pj1hzp.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1220&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">APRA’s letter is a get-out-of-jail card.</span>
</figcaption>
</figure>
<p>An announcement like APRA’s provides them with cover – an excuse.</p>
<p>And it does more. It is what economists refer to as a “coordination device”.</p>
<p>If the big four banks got together and agreed cut their dividends by the same amount, say in half (which would be illegal) investors would get no differential signal and no new information about which bank was “good” and which was “bad”.</p>
<p>APRA’s message opens up the possibility of all four coordinating without talking – merely by following advice.</p>
<p>As 2005 Nobel laureate Thomas Schelling put it in his book, <a href="https://www.hup.harvard.edu/catalog.php?isbn=9780674840317&content=reviews">The Strategy of Conflict</a>, </p>
<blockquote>
<p>people can often concert their intentions or expectations with others if each knows that the other is trying to do the same</p>
</blockquote>
<p>And they’ve an interest in coordinating. If one bank falls over during this crisis and needs to be bailed out that’s bad for all of them. All of their stock prices will tank, it will be hard for them to raise the capital they need to fund their operations.</p>
<p>Australia’s banks compete, but they are “frenemies”, right now more friends than enemies.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/why-bank-shares-are-climbing-despite-the-royal-commission-111175">Why bank shares are climbing despite the royal commission</a>
</strong>
</em>
</p>
<hr>
<p>We will have to wait and see if they pick up the get-out-of-jail card APRA has handed them and cut dividends together.</p>
<p>APRA could have taken a tougher stance. It could have banned dividends. But that would have sent a bad signal to domestic and international capital markets about the solvency of our banks.</p>
<p>I have been critical of some of APRA’s moves in recent years. But this one is brilliant. Let’s hope the banks can see a life raft when they’re offered one.</p><img src="https://counter.theconversation.com/content/136407/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Richard Holden does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>APRA is allowing the big four banks to coordinate in a way that might otherwise be illegal.Richard Holden, Professor of Economics, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1359282020-04-13T19:48:54Z2020-04-13T19:48:54ZThe last thing companies should be doing right now is paying dividends<figure><img src="https://images.theconversation.com/files/326754/original/file-20200409-112255-1lr4o0j.jpg?ixlib=rb-1.1.0&rect=461%2C143%2C2730%2C1479&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>The economic heart attack induced by COVID-19 has revealed an ugly truth – many very large companies have too little cash to ride out sharp downturns.</p>
<p>Cash flow variability, and the inability to retain earnings to buffer that variability, is one of the most common reasons small businesses fail. </p>
<p>Because large companies have raised large amounts of cash through public offers, and take in large amounts of cash in their ordinary operations, they ought to be more resilient. </p>
<p>Yet even though the pandemic-inspired shutdowns are mere weeks old, many big <a href="https://www.abc.net.au/news/2020-04-02/coronavirus-airline-bailout-virgin-qantas-failure/12110064">companies</a> such as Virgin Australia and listed childcare providers are already pleading for or receiving public <a href="https://www.bloomberg.com/news/articles/2020-04-08/banks-in-talks-with-bank-of-england-on-fresh-capital-relief">guarantees</a> and bailouts. </p>
<p>Other companies such as <a href="https://www.news.com.au/finance/business/breaking-news/flight-centre-taps-investors-for-700m/news-story/11ad7c049d59462cd51f0f705aa2000e">Flight Centre</a> and <a href="https://www.afr.com/chanticleer/the-warning-in-cochlear-s-capital-raising-20200325-p54dpb">Cochlear</a> are rushing to raise extra funds though discounted share placements.</p>
<p>Bond and debt markets are <a href="https://www.abc.net.au/news/2020-04-09/coronavirus-economy-printing-money-quantitative-easing/12134560?section=business">experiencing severe problems</a>, making it difficult for these companies to borrow.</p>
<h2>Why are big companies so vulnerable?</h2>
<p>Catastrophic declines in cash flow are only half the story.</p>
<p>The other half is the three-decade focus on maximising shareholder returns. </p>
<p>Companies have used four strategies to keep their share prices high and push them higher. </p>
<p>First, they have paid out profits to shareholders in the form of dividends, leaving them with less to build cash buffers, pay higher wages and reinvest in the business. </p>
<p>Reserve Bank research shows that over the past three decades dividend payouts have trended up over time to more than <a href="https://rba.gov.au/publications/bulletin/2016/mar/pdf/bu-0316-6.pdf">80 cents</a> of every dollar of corporate profits. </p>
<p>In some companies dividends payouts exceed 100% of profits.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/australias-appetite-for-dividends-could-cannibalise-economic-growth-46403">Australia's appetite for dividends could cannibalise economic growth</a>
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</em>
</p>
<hr>
<p>Second, the same Reserve Bank research points to the increased use of share buy-backs and dividend reinvestment plans. The former boosts share prices by shrinking the stock of shares. The latter boosts demand for that stock. </p>
<p>Third, to lock in these historically high dividend payout ratios, shareholders, including institutional shareholders such as superannuation funds, have demanded boards agree to <a href="https://www.telegraph.co.uk/finance/markets/questor/11593535/GSK-guarantees-5.4pc-dividend.html">dividend guarantees</a>.</p>
<p>In Australia these demands for higher and higher dividends have been partly driven by <a href="https://theconversation.com/words-that-matter-whats-a-franking-credit-whats-dividend-imputation-and-whats-retiree-tax-111423">dividend imputation</a> which attaches a “refund” of company tax to dividend payments, making them even more valuable to mum and dad investors, and also to super funds, which have a heavy bias to equities.</p>
<p>Fourth, executives have been incentivised to make sure share prices climb higher and higher by remuneration packages that provide bonuses linked to high share prices.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/words-that-matter-whats-a-franking-credit-whats-dividend-imputation-and-whats-retiree-tax-111423">Words that matter. What’s a franking credit? What’s dividend imputation? And what's 'retiree tax'?</a>
</strong>
</em>
</p>
<hr>
<p>Finally, companies have had to <a href="http://www.oecd.org/corporate/corporate-bond-debt-continues-to-pile-up.htm">borrow heavily </a>to cover ever increasing dividend payments and buybacks. </p>
<p>As Edward Altman, father of the <a href="https://seekingalpha.com/article/3895276-altman-z-score-after-50-years-use-and-misuse">Altman Z-score</a> for predicting bankruptcy, observes, the vast majority of US companies are now B rated (just above junk). Thirty years ago many were A rated. </p>
<p>Increased borrowing is making it hard for many companies to borrow more money or to issue bonds except at junk-grade interest rates. </p>
<p>The COVID-19 crisis has exposed the flaws of sucking liquidity out of companies to maximise shareholder returns as did the global financial crisis before it.</p>
<h2>Directors need to consider their legal duties</h2>
<p>Directors have a legal obligation not to trade while insolvent. Not having enough cash on hand to pay bills as and when they fall due triggers this obligation.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=840&fit=crop&dpr=1 600w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=840&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=840&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1056&fit=crop&dpr=1 754w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1056&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/326728/original/file-20200409-188923-1pxiqkj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1056&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.apra.gov.au/sites/default/files/2020-04/Capital%20management.pdf">APRA letter to financial institutions, April 7, 2020</a></span>
</figcaption>
</figure>
<p>In times of crisis where the solvency of corporations is a live question, preferencing shareholders over creditors and employees by paying dividends or buying back shares or borrowing to pay dividends is likely to be a breach of duties because it sucks even more liquidity out of the business and increases leverage. </p>
<p>Both the Bank of England and New Zealand’s Reserve Bank have stopped their banks <a href="https://www.smh.com.au/business/banking-and-finance/australia-s-big-four-banks-hit-by-rbnz-dividend-call-20200402-p54gc4.html">paying dividends</a>. </p>
<p>On Tuesday Australia’s Prudential Regulation Authority took the unusual step of writing to banks asking them to be <a href="https://www.apra.gov.au/capital-management">extremely cautious</a> about paying dividends. </p>
<p>The Australian Shareholders’ Association has urged the government not to go further and issue a formal direction to banks to suspend dividend payments, saying shareholders rely on dividends to “<a href="https://www.afr.com/companies/financial-services/new-zealand-orders-banks-to-stop-paying-dividends-20200402-p54g9p">cover their living expenses</a>”.</p>
<h2>Things can’t return to how they were before</h2>
<p>When the pandemic is over and the economy recovers it will become clear that the pre-crisis rates of shareholder returns were not sustainable. </p>
<p>Until then, the public might be being asked to pick up the tab to save needlessly febrile companies, just as it has picked up a different sort of tab as a result of <a href="https://theconversation.com/shareholder-activism-might-sound-good-but-its-delusional-to-think-it-will-change-anything-much-125807">systemic misconduct</a> in banking justified by need to keep shareholder returns high. </p>
<p>Post-crisis, companies should be made to wind back returns to shareholders in order to build adequate buffers, invest in their businesses and pay their workers more.</p><img src="https://counter.theconversation.com/content/135928/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andrew Linden received funding from RMITs EU Centre to conduct his doctoral research. The Centre is funded by the European Union</span></em></p><p class="fine-print"><em><span>Warren Staples has received funding from Australia China Council, Department of Foreign Affairs and Trade (DFAT), and the Victorian Managed Insurance Authority (VMIA). Warren is currently a member of the Institute of Public Administration Australia (IPAA) Victoria’s Sustainability Community of Practice (CoP) Advisory Committee.</span></em></p>Directors’ obsession with maximising shareholder value has sucked the liquidity out of companies, making them brittle in the face of crises.Andrew Linden, Sessional Lecturer, PhD (Management) Candidate, School of Management, RMIT UniversityWarren Staples, Senior Lecturer in Management, RMIT UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1171542019-05-20T13:27:18Z2019-05-20T13:27:18ZEmployee-owned companies perform better, but are resisted by banks, lawyers and governments<figure><img src="https://images.theconversation.com/files/275134/original/file-20190517-69192-p42lzf.jpg?ixlib=rb-1.1.0&rect=516%2C8%2C4783%2C2816&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Richer Sounds which will become the second most well-known employee-owned company after John Lewis.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/download/confirm/1344687110">Roger Utting/Shutterstock</a></span></figcaption></figure><p>Sick of seeing our shelves full of Beatles and Bob Marley LPs with no record player upon which to play them, our son visited Hi-Fi emporium Richer Sounds to buy us one. On finding it didn’t work he returned it to the nearest branch where they realised he’d been given the wrong cable, supplied the correct cable, issued a refund, and explained clearly how to set it up. If someone had asked me who should be running the company, the assistant serving us would have deserved consideration. </p>
<p>News that Julian Richer has now passed ownership of <a href="https://www.thisismoney.co.uk/money/news/article-7027965/Staff-Richer-Sounds-set-windfalls-20K-boss-hands-firm-employees.html">his company into an employee-owned partnership</a>, like that used at John Lewis, it so happens that that able shop assistant has in a way come to be his own boss. Most (60%) of the company’s shares will be placed in an employee ownership trust, with its 522 employees at 53 stores around the UK set to receive a share of a £3.5m payout. Richer has passed running the business to the management board, which will be advised by a newly arranged advisory council made up of current staff.</p>
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<img alt="" src="https://images.theconversation.com/files/275132/original/file-20190517-69209-zrilay.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/275132/original/file-20190517-69209-zrilay.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/275132/original/file-20190517-69209-zrilay.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/275132/original/file-20190517-69209-zrilay.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/275132/original/file-20190517-69209-zrilay.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/275132/original/file-20190517-69209-zrilay.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/275132/original/file-20190517-69209-zrilay.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Julian Richer, who after turning 60 has handed 60% of his company to an employee-owned trust.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/horse-racing-julian-richer-businessman-sounds-1171138714">Mick Atkins/Shutterstock</a></span>
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<p>At the John Lewis Partnership (which includes Waitrose), a portion of the profits each year is paid as a bonus to its employees, much like other companies pay a dividend to shareholders. John Lewis suffered a squeeze in profits in 2018-19, causing the bonus to be lower than at any time since 1953, when it was zero. However, John Lewis still paid a bonus, <a href="https://www.thetimes.co.uk/article/john-lewis-bonus-cut-to-3-as-profits-fall-by-half-8lx23ppjp">equal to 3% of salaries</a>. </p>
<p>On the same day as the Richer Sounds announcement, the Institute for Fiscal Studies <a href="https://www.bbc.co.uk/news/education-48229037">announced a review of inequality in Britain</a> by Nobel Prize-winning economist Sir Angus Deaton, who warned: “There’s a real question about whether democratic capitalism is working, when it’s only working for part of the population.” </p>
<p>But as a form of stakeholder capitalism, the <a href="https://global.oup.com/academic/product/the-oxford-handbook-of-mutual-co-operative-and-co-owned-business-9780199684977?cc=gb&lang=en&">evidence shows</a> that employee ownership boosts employee commitment and motivation, which leads to greater innovation and productivity.</p>
<p>Indeed, a <a href="https://smlr.rutgers.edu/sites/default/files/rutgerskelloggreport_april2019.pdf">study of employee ownership models in the US</a> published in April found it narrowed gender and racial wealth gaps. Surveying 200 employees from 21 companies with employee ownership plans, <a href="https://smlr.rutgers.edu/faculty-staff/joseph-r-blasi">Joseph Blasi</a> and his colleagues at Rutgers University found employees had significantly more wealth than the average US worker. </p>
<p>The researchers also found that the participatory management practices that accompanied the employee ownership schemes led to employees improving their communication skills and learning management skills, which had helped them make better financial decisions at home. </p>
<h2>Obstacles to employee ownership</h2>
<p>If research over the years has found that employee ownership is a successful corporate model, this raises the question of why, if this makes companies more successful, it is not more widely adopted. </p>
<p>Most obviously, current companty owners may wish to retain their ownership, regardless of how much better their employees might prove to be as co–owners. </p>
<p>And for most public listed companies, the real owners of the company are institutional shareholders such as pension funds and the like, in which case there is no easy mechanism for bringing about employee ownership. And even where there is a single owner, such as Richer, the advice from banks and legal advisers will be to consider floating on the stock exchange or selling up to a bigger firm. Corporate institutional culture is largely ignorant about employee ownership, or otherwise outright hostile towards it. </p>
<h2>Dropped political pledges</h2>
<p>The UK Coalition government of 2010-2015 pledged to banish that ignorance and hostility. Liberal Democrat leader Nick Clegg announcing they’d <a href="https://www.bbc.co.uk/news/uk-16570840">establish a centre</a> to promote the benefits of employee ownership, including for succession planning. It never happened – while less well-known than Clegg’s U-turn on student university fees, it was probably more damaging to the long-term success of the economy. </p>
<p>The Coalition government also pledged to promote corporate diversity, including in the financial services sector, but that pledge too was broken, with an <a href="https://www.cefims.ac.uk/research/papers/DP113">index of corporate diversity</a> showing no improvement over subsequent years. </p>
<p>So employee ownership can be more effective and such companies tend to have better outcomes. But these benefits don’t follow automatically: they require a considerable and sustained effort from management. This includes managers getting used to the idea that they’re answerable to the employees rather than shareholders. Research has found <a href="https://www.theguardian.com/politics/2002/dec/03/economy.comment">this can be a major hurdle</a>, not so much for the senior management who will generally appreciate the potential gain, but for middle management, who will have got used to the old, adversarial ways of giving orders.</p>
<p>It also requires the support of government, in the form of legislation and regulation. All three political parties claim to be supportive of employee ownership. Despite their failures in the Coalition government, the Liberal Democrats <a href="https://www.libdemvoice.org/the-liberal-plan-for-worker-coownership-59010.html">remain committed</a> to promoting employee ownership; when Theresa May became prime minister, she made supportive noises that included <a href="https://www.theguardian.com/politics/nils-pratley-on-finance/2016/jul/11/theresa-may-plan-workers-boardroom-reform-extraordinary-tories">proposals to put employees on company boards</a> (<a href="https://www.theguardian.com/business/2018/jun/10/theresa-may-misses-a-trick-after-u-turn-over-workers-on-boards">later quietly shelved</a>). Shadow Chancellor John McDonnell <a href="https://www.theguardian.com/politics/2018/sep/23/labour-private-sector-employee-ownership-plan-john-mcdonnell">pledged</a> that a Labour government will introduce employee ownership. </p>
<p>The key to the success of John Lewis over the decades has been not just the positive effects of employee ownership on employee motivation, commitment, innovation and productivity, but also that the employee trust is committed to promoting the interests of current and future employees. This has allowed them to <a href="http://news.bbc.co.uk/1/hi/business/the_company_file/451620.stm">sustain a more long-termist outlook</a>, for example in <a href="https://www.thisismoney.co.uk/money/markets/article-5697551/Amazon-sent-packing-talks-Waitrose-takeover.html">rejecting takeover bids</a> that might provide current employees with a windfall, but offer bleaker prospects for future generations of employees. </p>
<p>However, UK company law governing employee ownership trusts includes a rule against perpetuity: such trusts are limited to 125 years (previously 80). To establish the John Lewis Trust required an Act of Parliament, and relied upon a version of the <a href="http://eureka.sbs.ox.ac.uk/6431/">non-perpetuity rule</a> – dating from the time of the Crusades – under which the trust is limited to “21 years after the death of the last survivor of the descendants then living of the British monarch at the time”. In this case, 21 years after the death of Queen Elizabeth II. </p>
<p>This has to change. Otherwise, all gains from employee ownership that are won will prove temporary.</p><img src="https://counter.theconversation.com/content/117154/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jonathan Michie receives no research funding currently, but previously has from the Economic & Social Research Council, Leverhulme, the British Academy, the Royal Economic Society, the European Commission, the Higher Education Innovation Fund, the Department of Trade & Industry, the Environment Agency, and various other research funders. He is Director of the Oxford Centre for Mutual & Co-owned Business. </span></em></p>Employee-owned businesses benefit from boosted productivity, profitability, and staff morale. So why are they so rare?Jonathan Michie, Professor of Innovation & Knowledge Exchange, University of OxfordLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/951532018-04-22T19:17:08Z2018-04-22T19:17:08ZBig businesses who give shareholders tax credits pay more tax: study<p>Businesses who pay dividends to shareholders with tax credits attached pay more tax, new research finds. This occurs because of dividend imputation whereby shareholders get a credit for corporate tax the business pays, on the dividends they receive.</p>
<p>Over the period of 2004 to 2015, we studied financial statement data from companies listed on the Australian Stock Exchange. The study found that on average firms that pay dividends with tax credits have an effective tax rate of up to 16.9% higher than firms that don’t. They also have an effective tax rate of up to 14.7% higher than firms that do not pay dividends at all.</p>
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<p>Because we looked at listed businesses the results encompass Australia’s largest corporations. We found these results stand, despite a variety of reasons for why businesses are not paying tax in the current year, such as carrying tax losses forward.</p>
<p>This study shows there is a strong case for keeping Australia’s dividend imputation system, but it also puts the debate on company tax cuts in a new light. If we reduced or changed the dividend imputation system, the budget impacts of a reduction in corporate tax would likely be offset by reduced imputation credits and by individual investors paying higher tax. </p>
<p>The largest potential beneficiaries of a reduction in the corporate tax rate are foreign multinationals with operations in Australia - but they tend not to pay tax in Australia anyway. In other words “much ado about nothing”.</p>
<h2>How Australia’s tax system works against tax avoidance</h2>
<p>In a “classical tax system”, as exists in the United States, the European Union and most other countries, corporate profits are first taxed within the company at the corporate tax rate. Those after-tax profits are then distributed to shareholders as dividends. Shareholders pay tax on those dividends at their individual marginal rate. </p>
<p>However, this arrangement has been labelled as “double taxation” because profits are taxed first, at the full corporate tax rate and then at the shareholders individual marginal tax rate.</p>
<p>In various countries governments adjust for this by taxing dividend income for shareholders at a lower tax rate. But this is also problematic. </p>
<p>Taxing income at different rates creates an incentive for both companies and individuals to make money in a way in which they will taxed the least, distorting the efficient allocation of resources and other investment decisions. For example, if capital gains are concessionally taxed, companies will repurchase shares, rather than pay dividends.</p>
<p>A more extreme problem is that it provides an incentive for big businesses to avoid corporate tax in order to maximise after-tax profits. But in Australia, the incentives for corporate tax avoidance are reduced because shareholders receive a benefit through dividend imputation. </p>
<h2>Why we need to keep shareholder tax credits</h2>
<p><a href="https://theconversation.com/how-the-government-can-pay-for-its-proposed-company-tax-cuts-92739">Academics</a> and policymakers have called for Australia to dismantle the dividend imputation system, and this was canvassed in an <a href="http://bettertax.gov.au/publications/discussion-paper/">Australian Treasury Department discussion paper in 2015</a>. They make the argument that Australia is one of the few countries with a system of dividend imputation, that it costs government revenues over A$19 billion each year, and that it does little to attract foreign investment. </p>
<p>However, as a consequence of imputation, there is a much lower incidence of corporate tax avoidance by large domestic corporations <a href="https://doi.org/10.1016/j.jcorpfin.2017.10.007">in Australia than in other countries</a>. So any potential benefits to government revenues by dismantling or limiting dividend imputation would likely be diminished by increased corporate tax avoidance.</p>
<p>Australia would do better to focus its regulatory attention on foreign multinationals with operations in Australia. These companies do not utilise dividend imputation and <a href="http://parlinfo.aph.gov.au/parlInfo/download/legislation/ems/r5804_ems_5d93cda5-e8e4-4ed0-b40a-acd21555c8d6/upload_pdf/618592.pdf;fileType=application%2Fpdf">appear to pay little tax in Australia</a>.</p>
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<a href="https://theconversation.com/how-the-government-can-pay-for-its-proposed-company-tax-cuts-92739">How the government can pay for its proposed company tax cuts</a>
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<p>If we limit the refunds of imputation credits to shareholders, it could also reduce the incentives for corporations to pay dividends, and it could create an incentive for shareholders to invest instead in firms that don’t pay dividends with tax credits. </p>
<p>This may lead to less firms paying dividends with imputation tax credits and for these companies there will be increased incentives for corporate tax avoidance. This arises because limiting refunds for tax credits reduces the value of the credits to shareholders, and this restores the incentive for companies to engage in tax avoidance. </p>
<p>Tinkering at the edges of Australia’s system, such as getting rid of dividend imputation, is likely to have significant indirect and unexpected impacts. This identifies just one part of the complexity that exists within Australia, not only in the tax system but also with its interaction with other systems such as health and welfare. </p>
<p>What Australia still needs is broad tax reform and a much simpler system.</p><img src="https://counter.theconversation.com/content/95153/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Businesses who pay dividends to shareholders with tax credits attached pay more tax, new research finds.Roman Lanis, Associate Professor, Accounting, University of Technology SydneyBrett Govendir, Lecturer, Accounting Discipline Group, University of Technology SydneyPeter Wells, Professor, Accounting Discipline Group, University of Technology SydneyRoss McClure, PhD Candidate, casual academic, University of Technology SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/932802018-03-13T06:46:47Z2018-03-13T06:46:47ZViewpoints: could Labor’s tax changes make the system fairer or hurt investors?<p>The Australian Labor party <a href="http://www.abc.net.au/news/2018-03-13/labor-plan-scrap-5-billion-year-shareholder-refund-policy/9541016?section=business">will scrap</a> a system that refunds more than A$5 billion a year to low or zero tax paying investors, should they win government. </p>
<p>“<a href="https://www.investopedia.com/terms/f/frankingcredit.asp">Franking credits</a>” are designed to stop tax being paid twice on Australian corporate profits, allowing shareholders a credit for the tax paid by the company. But when shareholders don’t pay taxes at all they can claim a cash refund for unused credits from the tax office. </p>
<p>Scrapping cash refunds on unused franking credits could make the tax system fairer according to Danielle Wood, Brendan Coates and John Daley from the Grattan Institute. </p>
<p>But according to Gordon Mackenzie from UNSW, these cash refunds incentivise people to invest in Australian companies, and ending them could see super and self-managed super funds, in particular, pulling their investment from local companies. </p>
<p>Labor proposes to abolish cash refunds of unused franking credits for individuals and superannuation funds. Not for profits and universities, which do not pay income tax, will continue to receive cash refunds for franking credits.</p>
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<h2>A piecemeal move towards a fairer tax system</h2>
<p><strong>Danielle Wood, Brendan Coates and John Daley, Grattan Institute</strong></p>
<p>Labor’s proposal is not comprehensive tax reform. But in the absence of that holy grail, it is a piecemeal move towards a more equitable tax system. The change will primarily affect wealthy retirees. </p>
<p>The wealthiest 20% of retirees own 86% of shares held by older Australians outside of super. And among self-managed superannuation funds (primarily held by wealthier retirees), half of the refunds are currently going to people with balances over A$2.4 million.</p>
<p>Abolishing cash refunds for individuals and superannuation funds will raise about A$5 billion a year in extra revenue. About 33% will be paid by individuals (mostly in high wealth households), 60% will be paid by self-managed superannuation funds (typically held by wealthier retirees), and the remaining 7% will be paid by Australian Prudential Regulation Authority regulated superannuation funds.</p>
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<span class="attribution"><span class="source">ABS Survey of Income and Housing 2015-16</span>, <span class="license">Author provided</span></span>
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<p>Cash refunds on franking credits were introduced in 2001 for shareholders who had more franking credits than the tax they owed. The theory was that people with no or low income should have the same incentives to invest in Australian companies as other investors. </p>
<p>At the time, the decision cost the budget little – around A$550 million a year – because very few people with low income also owned shares.</p>
<p>But <a href="https://grattan.edu.au/report/super-tax-targeting/">new superannuation rules in 2006</a> relieved retirees from paying any tax on their superannuation withdrawals. Retirees also pay no tax on their super fund earnings. As more people with significant super balances retire, an increasing number qualify for cash refunds on unused franking credits.</p>
<p>And a series of changes to the Seniors and Pensioners Tax Offset <a href="https://grattan.edu.au/report/age-of-entitlement/">increased the proportion</a> of over-65s paying no tax on earnings outside of super.</p>
<p>The cash refund system now costs the federal budget more than A$5 billion a year. But abolishing cash refunds on dividends won’t be costless. </p>
<p>The franking credit regime was set up for a <a href="https://australiancentre.com.au/wp-content/uploads/2016/04/FAF3-Imputation-paper.pdf">variety of good reasons</a>. It aimed to bias Australians towards investing in Australia. In practice this appears to have led to Australian companies being funded more through equity and less through debt, improving financial stability. </p>
<p>In theory it would also lead to more physical investment in Australia, although there is less evidence that this has happened. </p>
<p>In practice, franking credits also encourage Australian companies to pay dividends rather than inefficiently hoard cash or invest in low-return projects.</p>
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<p>So abolishing cash refunds, but keeping franking credits for those who do pay income tax, is probably not the ideal policy. It abandons the principle that all company profits should be taxed at an investor’s marginal rate of income tax. And it reduces the incentive for retirees to invest in companies from Australia rather than overseas.</p>
<p>On the other hand, the decisions not to tax superannuation withdrawals and to increase the effective tax-free threshold for older Australians have led to wealthy retirees contributing very little to government revenues relative to younger households. </p>
<p>Even though the wealth of older generations has <a href="https://theconversation.com/three-charts-on-the-great-australian-wealth-gap-84515">jumped in line with asset prices</a>, the share of senior Australians who pay income tax <a href="https://theconversation.com/why-special-tax-breaks-for-seniors-should-go-69034">has nearly halved</a> – from 27% to 16% – in the past two decades. </p>
<p>In an ideal world the federal government would reintroduce a number of higher income and wealthy older Australians to the tax system by taxing superannuation earnings and abolishing age-based tax rates. But in the absence of the political will to make these changes, abolishing cash refunds provides a big boost to the budget bottom line from more or less the same group.</p>
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<h2>The changes could bring distortions to investors</h2>
<p><strong>Gordon Mackenzie, Senior Lecturer, University of New South Wales</strong></p>
<p>Chasing franking credits is one of the few tax issues that super fund investment managers take into account when investing, and is a significant consideration for self-managed super funds, according to <a href="https://search.informit.com.au/documentSummary;dn=424319838097596;res=IELBUS">my research</a> with Professor Margaret McKerchar. </p>
<p>As the previous authors mention, franking credits are intended as an incentive for certain investors to invest in Australian companies. Under the rules, super funds and self-managed super funds don’t pay tax when they are paying a retirement pension, if the account balance is below a certain level.</p>
<p>Since they pay no tax, it is worthwhile for these funds to invest in Australian companies that will pay franking credits. Doing so allows them to claim credits from the tax office. </p>
<p>But this also means that if cash refunds on franking credits are done away with, it is an implicit 30% tax increase on super and self-managed funds that invest in Australian companies. This creates an incentive for them to put their money elsewhere.</p>
<p>If these funds invest in something like a government bond then they will pay no tax on the profits. If they invest in an Australian company, the company will pay the corporate tax and there will be no way for super funds to claim the tax back. </p>
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<a href="https://theconversation.com/tax-reform-aside-theres-no-real-case-to-kill-off-dividend-imputation-49584">Tax reform aside, there's no real case to kill off dividend imputation</a>
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<p>Many self-managed super funds have accounts for paying a pension to the member and another account for accumulating funds, but not paying out anything. Self-managed super funds will likely replace Australian shares in their pension accounts with assets such as bonds or managed funds. </p>
<p>This is important, as <a href="https://www.ato.gov.au/Super/Self-managed-super-funds/In-detail/Statistics/Quarterly-reports/Self-managed-super-fund-statistical-report---September-2017/?anchor=Assetallocationbyassetvalue#Assetallocationbyassetvalue">data shows</a> that Australian shares are one of the largest asset classes held by self-managed super funds, ranging between 21% and 30.8% of the entire portfolio, depending on the size of the fund. </p>
<p>The response of other types of superannuation funds will probably be more muted. While they do value imputation credits, they also care about diversifying their portfolios - there will still be benefits to holding some Australian shares.</p>
<p>Overall, then, imputation credits are important to superannuation funds, both big and small. The refund not only makes certain types of investment attractive, but also drives how much is invested in that type of investment.</p><img src="https://counter.theconversation.com/content/93280/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Grattan Institute began with contributions to its endowment of $15 million from each of the Federal and Victorian Governments, $4 million from BHP Billiton, and $1 million from NAB. In order to safeguard its independence, Grattan Institute’s board controls this endowment. The funds are invested and contribute to funding Grattan Institute's activities. Grattan Institute also receives funding from corporates, foundations, and individuals to support its general activities as disclosed on its website.</span></em></p><p class="fine-print"><em><span>Gordon Mackenzie receives funding from CAANZ. </span></em></p>Scrapping cash refunds on dividends could make the tax system fairer. But super funds could invest less in Australian companies.Danielle Wood, Program Director, Budget Policy and Institutions, Grattan InstituteBrendan Coates, Fellow, Grattan InstituteGordon Mackenzie, Senior Lecturer, UNSW SydneyJohn Daley, Chief Executive Officer, Grattan InstituteLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/903862018-01-23T19:12:16Z2018-01-23T19:12:16ZCompanies that pay more tax deliver shareholders better returns: new study<p>Treasurer Scott Morrison <a href="http://sjm.ministers.treasury.gov.au/transcript/003-2018/">is quick to spruik the shareholder benefits</a> of cutting corporate tax rates further, as the usual logic goes that if a corporation pays less tax, shareholders should get a greater return.</p>
<p>But in a recent pilot study, we found companies that paid a greater percentage of their sales or revenues as tax, provided shareholders with a larger return on their investment both as dividends and share capital growth.</p>
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Read more:
<a href="https://theconversation.com/three-strategies-to-fight-the-tax-avoidance-revealed-by-the-paradise-papers-87002">Three strategies to fight the tax avoidance revealed by the Paradise Papers</a>
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<p>We looked at dividends, share price returns and income tax data of ASX200 listed companies from 2012 till 2017. We found that a higher percentage of tax paid by a corporation correlated with a higher return on investment for shareholders in the form of dividends. We also found that share prices were more likely to increase. </p>
<p>Clearly, factors besides tax may have influenced these results. However, the fact that shareholders appear to achieve greater returns from corporations which are less aggressive tax planners and pay a greater percentage of tax is reason to pause. </p>
<h2>Why more tax and more returns</h2>
<p>Perhaps the most obvious explanation for these findings is Australia’s dividend imputation system. This means company tax paid in Australia is ultimately refunded to shareholders. It also means that the motivation for companies to lower the tax they pay may not be as pervasive an issue as it is under other countries’ corporate tax systems. </p>
<p>Australia is one of a limited number of countries that has a dividend imputation system to ensure company profits are taxed only once. This is in contrast with the US, which operates under a classical system where profits are taxed in the hands of the company and, when distributed as dividends, are taxed a second time in the hands of the shareholders. </p>
<p>In Australia, shareholders are provided with a credit for the company tax already paid, effectively meaning that tax is only paid on the difference between the corporate tax rate and the individual tax rate, potentially as high as 47%. As such, the corporate tax rate has very little effect on Australian resident shareholders. The story is not the same for foreign investors as company tax is treated as a final tax. In this case, foreign investors do not get the benefit of Australia’s imputation system, effectively resulting in the corporate tax paid being the tax paid by the shareholder.</p>
<p>Another explanation for our findings could be that external regulatory and public pressures mean that companies and their shareholders recognise the need to pay tax as a social responsibility. People’s attitudes towards aggressive tax planning by corporations have changed significantly since reports of <a href="https://theconversation.com/more-than-naming-and-shaming-needed-to-stop-corporate-tax-avoidance-46318">corporate tax scandals</a> and leaks such as <a href="https://theconversation.com/au/topics/panama-papers-26281">the Panama Papers</a>. This is coupled with the <a href="http://www.oecd.org/tax/beps/">OECD’s program</a> designed to address corporate tax avoidance along domestic tax reform measures, which began mid-2013. </p>
<h2>Shareholders might not benefit from tax cuts</h2>
<p>Our findings come at a time when we are seeing calls for a reduction in corporate tax rates. The <a href="http://www.imf.org/en/Publications/WEO/Issues/2018/01/11/world-economic-outlook-update-january-2018">IMF</a> recently announced that its revised growth forecasts were partly attributed to the expected impact of the recent US tax policy changes. Under new law, the US federal corporate tax rate has been reduced from 35% to 21%. </p>
<p>Australia’s corporate tax rate for entities with a turnover of less than A$25 million in 2017-18 is 27.5% and for all others remains at 30%. The government wants to introduce tax cuts for larger corporations which would ultimately see all companies paying corporate tax at a rate of 25%. </p>
<p>A comparison of the statutory tax rate, specified by law, also does not tell the full story. In March 2017, the <a href="https://www.cbo.gov/system/files/115th-congress-2017-2018/reports/52419-internationaltaxratecomp.pdf">US Congressional Budget Office</a> released a comparative study of global corporate tax rates, also comparing average corporate tax rates. It reveals that the average US rate is more like 29% while Australia is already significantly below that rate at 17%. </p>
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Read more:
<a href="https://theconversation.com/race-to-the-bottom-on-company-tax-cuts-wont-stop-tax-avoidance-69209">Race to the bottom on company tax cuts won't stop tax avoidance</a>
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<p>As the US Congressional Budget Office explains, corporations tend to consider the average corporate tax rate when deciding to undertake a large or long-term investment in a country. This is because it’s this rate that reflects a country’s tax preferences for business and legal tax planning strategies. In contrast, the statutory corporate tax rate is more of a concern for multinational corporations wishing to shift profits from a high tax country to a low tax country. </p>
<p>Our findings suggest that shareholders may not receive greater returns from corporations which pay less tax. A reduction in the corporate tax rate is likely to lead to a further reduction in the effective tax rate and taxes paid as a percentage of sales or revenues. </p>
<p>Our pilot study indicates that shareholders at least may not benefit from such a reduction. Corporations paying their “fair share” of tax may potentially be regarded favourably by shareholders, in much the same vein as environmental and governance concerns. So we shouldn’t assume that corporations paying less tax is good for shareholders in Australia.</p><img src="https://counter.theconversation.com/content/90386/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kerrie Sadiq has received funding from the International Centre for Tax and Development, CAANZ and CPA. She is a Senior Adviser to the Tax Justice Network (UK).</span></em></p><p class="fine-print"><em><span>Bronwyn McCredie has received funding from the Accounting and Finance Association of Australia and New Zealand (AFAANZ) and CPA Australia.</span></em></p>Shareholders appear to achieve greater returns from corporations which are less aggressive tax planners and pay a greater percentage of tax, according to a new pilot study.Kerrie Sadiq, Professor of Taxation, QUT Business School, Queensland University of TechnologyBronwyn McCredie, Lecturer, QUT Business School, Queensland University of TechnologyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/737662017-03-03T00:44:38Z2017-03-03T00:44:38ZThree reasons businesses are paying higher dividends rather than investing<figure><img src="https://images.theconversation.com/files/158840/original/image-20170301-29906-5utgwp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">More than A$72 billion has been paid in dividends in 2016-17.</span> <span class="attribution"><span class="source">AAP/Dean Lewins</span></span></figcaption></figure><p>Typically, low interest rates, together with record profits, would create an environment in which businesses would be happy to invest in new projects – providing a boost to economic growth and jobs. Unfortunately, Australians do not appear to be living in “typical” times. Rather than lifting investment, businesses <a href="http://www.afr.com/markets/asx-200-dividend-count-heads-to-record-72bn-on-resources-comeback-20170224-gukd0j">have chosen</a> to return cash to shareholders in the form of <a href="http://www.abs.gov.au/AUSSTATS/abs@.nsf/Lookup/5676.0Main+Features1Dec%202016?OpenDocument">record dividends</a> and share buybacks.</p>
<p>There are many possible reasons – including political uncertainty – why businesses are seemingly ignoring the supportive economic environment and paying such large dividends (A$72 billion in 2016-17) instead of reinvesting in growth opportunities. </p>
<p>Three likely candidates are firm commitments to set dividend payouts, the sustainability of current commodity prices, and a perceived lack of investment opportunities.</p>
<p>This is not necessarily bad for the economy. Private investors will be happy to have more cash in their pocket, and at least some of the extra cash handed to shareholders will result in increased consumption, which may encourage businesses to invest in the future.</p>
<h2>Three key reasons</h2>
<p>Having come to the end of a major investment cycle, many resources companies are reluctant, for example, to build more mines and create more supply, as this creates downward pressure on prices. These companies have committed to a set dividend payout ratio. Mining giant <a href="http://www.afr.com/business/mining/bhp-billitons-bumper-profit-lifts-dividends-20170221-guhoeu">BHP Billiton</a>, for example, promises to pay its shareholders at least 50% of underlying profits.</p>
<p>The high level of dividends in the mining sector probably says something about the sustainability of current commodity prices. Despite extra supply from a number of additional mines (and increased production from existing mines) being available in 2016, the iron ore price <a href="https://thewest.com.au/business/fmg-rewards-investors-with-sharp-rise-in-profits-ng-b88394202z">has surged</a> to more than US$90 per tonne.</p>
<p>However, for mining companies to justify investing the billions of dollars required for a new mine, they need to have some comfort that such prices will persist. While the majority of forecasters have revised up their estimates, the consensus is still for the price to <a href="http://www.theaustralian.com.au/business/mining-energy/ord-minnett-lifts-2017-iron-ore-price-forecast/news-story/63a174477dda6339e5b876faaf9b57fb">fall below</a> US$60 per tonne by 2018. </p>
<p>The third reason is a perceived lack of investment opportunities. One explanation for this may be a reduction in infrastructure spending by state and federal governments owing to <a href="http://www.investordaily.com.au/markets/40402-lack-of-projects-stifling-infrastructure-investment">fiscal constraints</a>.</p>
<p>If businesses cannot identify a project that provides an adequate return on capital, then they are better off returning cash to shareholders. <a href="http://www.investopedia.com/articles/02/010902.asp">Corporate finance theory</a> would suggest this is good. </p>
<h2>What about political uncertainty?</h2>
<p>Perhaps the largest drag on investment results from the high level of uncertainty about the geopolitical environment. </p>
<p>Domestically, there appears to be little policy direction from a Coalition government wary of a rise in populism. </p>
<p>Regionally, Reserve Bank Governor <a href="http://www.rba.gov.au/speeches/2017/sp-gov-2017-02-24.html">Phillip Lowe</a> has identified possible risks in China owing to a continued build-up of debt. </p>
<p>And, globally, the Trump administration is perhaps the biggest cause of uncertainty. </p>
<p>In the months since Donald Trump’s victory in the US presidential election, global sharemarkets have rallied strongly. Australia’s market has been no different.</p>
<p>The All Ordinaries index has risen by 10% in the past quarter. However, the key to maintaining high prices is earnings growth. </p>
<p>The February earnings season did not disappoint in this respect. For the last quarter of 2016, Australian businesses reported the <a href="http://www.afr.com/news/economy/business-profits-shatter-expectations-inventories-hold-ground-20170227-gulzhg?login_token=1UZXumTn4h-43F5vZJ0QD2dus0wdSchPrpvvjWsnDgjG9IGS2VPlyecD1fUk0M1rk4tKscIDnUmbLueM_azPvg&expiry=1488313477&single_use_token=7HtqqeQ2AmYd_v3OsuJ90gZ7G1hInuTHy4c_lhDVCbveVTjHkRY7w3R4tdJkoMM0eNhgv_0IIRkWk3ChkuwBUQ">biggest earnings increase since 2001</a> – well ahead of market expectations.</p>
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<p>The <a href="http://www.abs.gov.au/AUSSTATS/abs@.nsf/Lookup/5676.0Main+Features1Dec%202016?OpenDocument">strong results</a> have largely been driven by a 21% (A$4 billion) surge in mining industry profits. Thanks to a dramatic increase in commodity prices, tighter cost controls and increased efficiencies, the industry reported gross profits (trend estimate) of more than A$24 billion for the quarter. </p>
<p>Across the board, firm profitability has benefited from below-trend growth in wages.</p>
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<p>Deregulation, infrastructure investment and tax reform could boost global growth and encourage investment by Australian firms in the process. However, negatives resulting from the potential for trade war (or worse) owing to the redrawing of US foreign policy will clearly hold back investment.</p>
<p><a href="https://espace.curtin.edu.au/handle/20.500.11937/38374">My research</a> has shown that political uncertainty is ultimately a negative for sharemarkets. Frictions in the investment decision process act as one mechanism for this relationship. In the meantime, shareholders should enjoy the benefit of higher dividend payouts while they last.</p><img src="https://counter.theconversation.com/content/73766/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Lee Smales does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Rather than lifting investment, Australian businesses have chosen to return cash to shareholders in the form of record dividends and share buybacks.Lee Smales, Associate Professor, Finance, Curtin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/647682016-09-02T13:32:28Z2016-09-02T13:32:28ZHow to ditch corporation tax and grow government income at the same time<figure><img src="https://images.theconversation.com/files/136278/original/image-20160901-1061-1eey8jl.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Ta-dah!</span> <span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-66896299/stock-photo-cute-dappled-rabbit-sitting-in-a-black-magicians-hat.html?src=qs85WiM528xGp22KAFwv8Q-1-14">Volkova</a></span></figcaption></figure><p>Another day, another tax headline. This week, <a href="http://www.bbc.co.uk/news/world-europe-37242357">it’s Apple</a>, which faces a €13 billion (£11bn) tax bill in Ireland from the EU. Everyone says there must be a better way to make business pay its way. I support boosting the tax take, too, though not by punishing companies. Earlier this year, I <a href="https://theconversation.com/corporation-tax-the-progressive-case-for-getting-rid-of-it-56452">argued</a> in The Conversation that it was time for progressives to think the unthinkable and get rid of corporation tax. </p>
<p>UK politicians remain to be convinced, alas. The All Party Parliamentary Group’s <a href="http://www.appgresponsibletax.org.uk/wp-content/uploads/2016/08/Sticking-Plaster-APPG-Responsible-Tax-Report.pdf">recent report</a> on the global tax system stated:</p>
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<p>Some experts have argued that we should stop trying to tax the profits of global companies. We disagree. Governments need a range of taxes to fund public services and corporate profits form one part of that range.</p>
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<p>They haven’t recognised that you could bring in much the same revenue for the state by shifting the burden to shareholders. How? By fully taxing company dividends – and reaping the tax proceeds of people selling UK shares that have risen because of companies becoming more profitable after being freed from corporation tax.</p>
<p>But here I want to propose another carrot: charge companies an annual fee to be registered in the UK. </p>
<h2>Ever-decreasing corporation tax</h2>
<p>Corporation tax <a href="https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/539194/Jun16_Receipts_NS_Bulletin_Final.pdf">brings in</a> around 6% (net of dividend allowance) of UK tax revenues. Former chancellor George Osborne <a href="http://www.bbc.co.uk/news/business-36699642">intended</a> in the wake of Brexit to cut UK rates from the current 20% to 15% of companies’ pre-tax profits. Philip Hammond, his replacement, has yet to announce a policy but <a href="http://www.dailymail.co.uk/news/article-3704195/Hammond-cut-corporation-VAT-tax-economy-stalls-Chancellor-raises-expectations-revealing-plans-reset-policy.html">has signalled</a> he may move in the same direction. </p>
<p>Coupled with further erosions to the corporate tax base due to internet trading and the relocation of intellectual property to more favourable tax regimes, the day is soon likely to arrive when the UK struggles to raise 4% of its tax revenues from corporation tax. What’s this in money terms? Say £20bn (<a href="https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/539194/Jun16_Receipts_NS_Bulletin_Final.pdf">compared to</a> £30bn, net of tax credits, in 2015-16).</p>
<p>So how much corporation tax would be raised on average from UK companies each year if tax revenues fell to £20bn? <a href="https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/545611/StatisticalReleaseIncorporatedCompaniesUKJune2016_V1.1.pdf">There are</a> 3.5m limited companies in the UK. But 2m are dormant, so only 1.5m are actively trading. This means that each company would be paying just over £13,000 each year to HMRC on average. </p>
<p>I don’t know the average cost of a company complying with corporation tax each year, but it won’t be far removed from £13,000 (much higher for multinationals, much lower for small companies). And while companies only pay taxes when they make profits, they must make tax returns either way. It’s also worth remembering that many companies are subject to investigations, make appeals and sometimes end up in court – more costs. </p>
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<a href="https://images.theconversation.com/files/136281/original/image-20160901-1036-trc8kf.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/136281/original/image-20160901-1036-trc8kf.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/136281/original/image-20160901-1036-trc8kf.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=480&fit=crop&dpr=1 600w, https://images.theconversation.com/files/136281/original/image-20160901-1036-trc8kf.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=480&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/136281/original/image-20160901-1036-trc8kf.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=480&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/136281/original/image-20160901-1036-trc8kf.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=603&fit=crop&dpr=1 754w, https://images.theconversation.com/files/136281/original/image-20160901-1036-trc8kf.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=603&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/136281/original/image-20160901-1036-trc8kf.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=603&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Profit-seeking missile.</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-202197343/stock-vector-businessman-running-away-from-rocket-tax.html?src=j3kNoH3ShB-AEWRsra4UMA-1-78">BoBaa22</a></span>
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<h2>Plan B</h2>
<p>Now suppose we charged an annual fee for the privilege of being a UK company, using a fee scale based on company size. While companies would now be paying to be UK-registered, most would save more by not having to comply with corporation tax. </p>
<p>You could set the fee levels to bring in roughly what the government lost in corporation tax. In addition, the government would still have the revenue from the higher dividends and capital gains I mentioned earlier. In total, the income for the state would have risen substantially. </p>
<p>Collection of this fee would be simple. Companies would pay it when they deliver their <a href="https://www.gov.uk/government/publications/confirmation-statement/confirmation-statement">confirmation statement</a> (the replacement for the annual return). Penalties and interest would apply if payments were late – another source of money for government. </p>
<p>More information would be required to determine the number of fee bands and the charge per band for these new company fees, but below is a possible structure. Though the rates would of course be much higher for big companies, these are probably still comparable to what they spend on dealing with their tax affairs. </p>
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<a href="https://images.theconversation.com/files/136277/original/image-20160901-1023-1hwrc3n.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/136277/original/image-20160901-1023-1hwrc3n.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/136277/original/image-20160901-1023-1hwrc3n.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=156&fit=crop&dpr=1 600w, https://images.theconversation.com/files/136277/original/image-20160901-1023-1hwrc3n.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=156&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/136277/original/image-20160901-1023-1hwrc3n.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=156&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/136277/original/image-20160901-1023-1hwrc3n.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=196&fit=crop&dpr=1 754w, https://images.theconversation.com/files/136277/original/image-20160901-1023-1hwrc3n.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=196&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/136277/original/image-20160901-1023-1hwrc3n.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=196&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<p>I’ve spoken to a few people who run or are involved with companies about how they would react to a system like this. What was their reaction? They’d bite your hand off to sign up, basically.</p>
<p>And a final thought. If the UK abolished corporation tax, where do you think Apple, Google and others would consider relocating given the problems the EU has created for Ireland?</p><img src="https://counter.theconversation.com/content/64768/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Grahame Steven does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Arguments about reducing the tax burden of companies tend to get associated with rabid neoliberals. Here’s why they needn’t be.Grahame Steven, Lecturer in Accounting, Edinburgh Napier UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/564522016-03-18T10:03:57Z2016-03-18T10:03:57ZCorporation tax: the progressive case for getting rid of it<p>George Osborne, the UK chancellor, announced that corporation tax <a href="https://www.gov.uk/government/news/budget-2016-some-of-the-things-weve-announced">will be cut to 17% in 2020</a>. But why stop there? There’s a very good case for thinking the unthinkable and getting rid of corporation tax altogether. </p>
<p>For one thing, corporation tax does not bring in huge tax receipts. Last year the onshore component <a href="https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/501040/Jan16_Receipts_NS_Bulletin_Final.pdf">brought in</a> 8% of all UK tax. And this is a gross figure, which excludes the <a href="https://www.gov.uk/tax-on-dividends/how-dividends-are-taxed">tax credits</a> that taxpayers receive on dividends (to be replaced in April by a <a href="https://www.gov.uk/government/publications/dividend-allowance-factsheet/dividend-allowance-factsheet">tax-free allowance</a>). By my reckoning, the true contribution that corporation tax makes to the tax take is more like 6%. </p>
<p>Corporation tax <a href="https://data.oecd.org/tax/tax-on-corporate-profits.htm">has been</a> raising less and less money worldwide in recent years because governments have been competing with one another to reduce rates. Having peaked at 13% of global GDP in 2006, it was down to 7% by 2014. There’s every reason to assume that this trend will continue, particularly as multinationals become better at avoiding tax liabilities in any one country. Why fight this race to the bottom?</p>
<p>But there’s another important argument for why corporation tax matters less than you think: get rid of it and the money would still reach the government in other ways. Suppose a company with 100m shareholders has decided to distribute all its after-tax profit of £50m to its shareholders - a dividend of £0.50 a share would be paid. That means that a shareholder with 10,000 shares would receive a £5,000 dividend. Assuming this was their only dividend income that year, they would pay no tax on it because of the <a href="https://www.gov.uk/government/publications/dividend-allowance-factsheet/dividend-allowance-factsheet">£5,000 dividend allowance</a>. </p>
<p>Now consider what would happen if there was no corporation tax and no dividend allowance. The person receiving the dividend would be taxed on it as if it were any other income. Instead of the tax liability disappearing, it simply shifts from company to individual. Assuming they were a basic-rate taxpayer being taxed at 20%, this would mean that the company would have to pay them a dividend of £6,250 for them to receive £5,000. It makes you realise that under the current system, corporation tax is effectively a pre-paid income tax. </p>
<h2>FAQs</h2>
<p>Yet if you were going to shift the tax liability to the person receiving the dividend in this way, you might have spotted an issue. Most companies do not distribute all of their profits to shareholders. UK companies pay out about <a href="http://www.telegraph.co.uk/finance/personalfinance/investing/12006273/The-chart-that-shows-UK-dividends-are-reaching-breaking-point.html">50%</a> of profits as dividends. And some, such as Ryanair, don’t pay dividends at all. So would HMRC lose out?</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/115501/original/image-20160317-30231-1std34g.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/115501/original/image-20160317-30231-1std34g.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/115501/original/image-20160317-30231-1std34g.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=932&fit=crop&dpr=1 600w, https://images.theconversation.com/files/115501/original/image-20160317-30231-1std34g.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=932&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/115501/original/image-20160317-30231-1std34g.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=932&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/115501/original/image-20160317-30231-1std34g.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1172&fit=crop&dpr=1 754w, https://images.theconversation.com/files/115501/original/image-20160317-30231-1std34g.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1172&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/115501/original/image-20160317-30231-1std34g.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1172&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Going up?</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/cat.mhtml?lang=en&language=en&ref_site=photo&search_source=search_form&version=llv1&anyorall=all&safesearch=1&use_local_boost=1&autocomplete_id=&searchterm=share%20chart&show_color_wheel=1&orient=&commercial_ok=&media_type=images&search_cat=&searchtermx=&photographer_name=&people_gender=&people_age=&people_ethnicity=&people_number=&color=&page=1&inline=391272478">Mclek</a></span>
</figcaption>
</figure>
<p>The answer is no. Get rid of corporation-tax liability and the share prices of companies would rise to reflect their extra net worth. The lower the dividend payout, the higher the share price. When shareholders sell their shares, this means they will make a higher capital gain, which means greater income-tax receipts for HMRC.</p>
<p>You might be wondering whether in a system like this, people would be more likely to invest in something other than shares and that the tax receipts would therefore be lost. I suspect companies would still look like a good investment overall, particularly because they would have become worth more and investors value the protection afforded by limited liability.</p>
<p>There is still the problem that governments want their money sooner rather than later since they have to fund public expenditure. Relying on tax receipts from dividend/share-sale income would potentially be slower than getting them from corporation tax. You could get around this by levying a withholding tax of say 20% on companies when they pay dividends – meaning the dividend income would be paid net of the withholding tax, which the company would be responsible for paying to HMRC – in a similar way to how VAT works. And levying a withholding tax, say 2%, when a shareholder sells shares.</p>
<p>You would then have to adjust the individual’s tax liability to take account of these withholding taxes. This would encourage taxpayers to declare all their income and complete tax returns, since they may be entitled to a tax refund. If you wanted to encourage them further, you could set the withholding tax at a higher rate – say 40% for dividends. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/115502/original/image-20160317-30244-8n85tq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/115502/original/image-20160317-30244-8n85tq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/115502/original/image-20160317-30244-8n85tq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=424&fit=crop&dpr=1 600w, https://images.theconversation.com/files/115502/original/image-20160317-30244-8n85tq.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=424&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/115502/original/image-20160317-30244-8n85tq.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=424&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/115502/original/image-20160317-30244-8n85tq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=533&fit=crop&dpr=1 754w, https://images.theconversation.com/files/115502/original/image-20160317-30244-8n85tq.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=533&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/115502/original/image-20160317-30244-8n85tq.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=533&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">‘One for you, 19 for me.’</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/cat.mhtml?lang=en&language=en&ref_site=photo&search_source=search_form&version=llv1&anyorall=all&safesearch=1&use_local_boost=1&autocomplete_id=&search_tracking_id=adhRP5br16s7ZkObDspxjQ&searchterm=tax%20liability&show_color_wheel=1&orient=&commercial_ok=&media_type=images&search_cat=&searchtermx=&photographer_name=&people_gender=&people_age=&people_ethnicity=&people_number=&color=&page=1&inline=389062894">Ho Yeow Hui</a></span>
</figcaption>
</figure>
<p>Yes this system brings its own complexities, but they are not insurmountable. There is no perfect tax system. And shifting the corporation-tax burden to the individual would have other benefits. HMRC would transfer resources devoted to corporation tax to income taxes, which should bring in more tax receipts. Many people, including Labour leader <a href="http://labourlist.org/2015/07/you-just-cannot-cut-your-way-to-prosperity-jeremy-corbyn-outlines-plans-to-make-large-reductions-in-93bn-of-corporate-subsidies/">Jeremy Corbyn</a>, argue that a better-resourced tax authority would benefit in this way. </p>
<p>Companies would save money since they wouldn’t have to pay their accountants to deal with corporation tax. Needless to say it would create a more business-friendly environment, which would make the UK a more attractive place for companies to invest – and I say all this as a believer in public services and progressive taxation. Once you recognise that doing away with corporation tax doesn’t mean losing tax revenues, these benefits hopefully become more persuasive.</p><img src="https://counter.theconversation.com/content/56452/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Grahame Steven does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Why stop at 17%?Grahame Steven, Lecturer in Accounting, Edinburgh Napier UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/552272016-02-24T00:42:03Z2016-02-24T00:42:03ZSay what you like about BHP, it didn’t squander the boom<p>During the commodity price boom from 2004-2011 BHP Billiton’s board raised the firm’s dividend to an unsustainable level. Now, in the commodity bust, the board has been forced to cut it by 75%.</p>
<p>The board has been heavily criticised for its conduct of dividend policy. Critics have focused mainly on the type of dividend policy and timing of dividend changes. But that misses the big picture in a cycle of boom and bust.</p>
<p>The performance of BHP’s board and its management should be measured by the amount of shareholder value created, after controlling for factors beyond their control. Was the windfall of cash generated in the mining boom either invested wisely or paid out to shareholders, or was it wasted on bad investment and value-destroying acquisitions? The latter has been the historical normal for global resource companies through resource boom and bust cycles.</p>
<h2>The windfall</h2>
<p>BHP’s operating cash flows grew from US$5 billion in 2004 to US$30 billion in 2011. BHP’s board responded by increasing dividends nearly sixfold, from 9.5 to 55 US cents per share in just the seven years from 2004 to 2011 (29% annual growth). In the following four years dividends grew only another 7 cents per share (3% annual growth).</p>
<p>After 2011 the price of all of BHP’s commodities fell – first slowly and then quickly. Cash flow shrank to the point that BHP’s board was forced to choose between its “progressive” dividend policy and its “A” credit rating. The credit rating prevailed.</p>
<p>Before being too critical of the BHP board for not implementing its own dividend policy, we should consider the whole picture of how BHP used its cash flows in the 2004-2011 period.</p>
<iframe src="https://charts.datawrapper.de/9qGhb/index.html" frameborder="0" allowtransparency="true" allowfullscreen="allowfullscreen" webkitallowfullscreen="webkitallowfullscreen" mozallowfullscreen="mozallowfullscreen" oallowfullscreen="oallowfullscreen" msallowfullscreen="msallowfullscreen" width="100%" height="300"></iframe>
<p>What does this table above tell us about BHP’s management of its cash flows?</p>
<p>Debt reduction, share buybacks, dividends: US$25 billion of the windfall of cash was used for debt reduction. Another US$44 billion was returned to shareholders in the form of share buybacks (US$22 billion) and dividends (US$22 billion) – a total of US$69 billion. Thank goodness for that.</p>
<p>Acquisitions: BHP spent “only” US$11 billion of its cash flows on acquisitions in this period: US$6 billion on Western Mining in 2005 and US$5 billion on the Fayetteville gas assets. Another US$15 billion was spent on the Petrohawk gas assets only days after the end of this period. </p>
<p>Unfortunately, the first half earnings announcement included a write-down of the US gas assets by US$7.2 billion. But criticism of the purchase of those assets relies mainly on the advantage of hindsight.</p>
<p>Nonetheless, it is by good luck rather than good management that more was not wasted on expensive acquisitions – especially in BHP’s failed bid for Rio Tinto when then CEO Marius Kloppers offered to pay at least US$20 billion over the odds for Rio. This assessment does not rely on hindsight. It is based on the increase in the BHP share price and decline in Rio Tinto’s share price at the time the BHP bid was withdrawn.</p>
<p>Capital expenditure: BHP spent the largest part of its extra cash flow on expanding production. There is always a danger that firms that receive cash windfalls will waste the cash on low-return investment projects. For the most part BHP has not done that in this cycle – although the plans for the US$20 billion expansion of the harbour in Port Hedland were a very worrying sign.</p>
<p>After considering how BHP’s windfall of cash flow was used in the boom period of 2004-2011, is it right to criticise the BHP board for paying out a large amount of cash as dividends, even if that made dividends unsustainable?</p>
<h2>The verdict</h2>
<p>The board might have made greater use of buybacks, especially to buy back more shares in London where BHP shares traded at a large discount to the same share on the ASX. It might also have declared “special dividends”, but that would have signalled they did not believe the cash flows were permanent.</p>
<p>But those considerations about how cash should be paid out of the firm are not the first-order issue when an unanticipated surge of cash flows occurs. The total volume of cash paid out is what shareholders should focus on. BHP’s board should be applauded for raising dividends during the boom. That proved unsustainable, but so what?</p>
<p>Overall, BHP’s board has done a reasonably good job of not squandering the proceeds of the mining boom. The fact that its dividend policy proved unsustainable is simply not the main issue.</p><img src="https://counter.theconversation.com/content/55227/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Sam Wylie does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>BHP’s board has navigated well through mining’s highs and lows and still passed the shareholder value test.Sam Wylie, Principal Fellow, Melbourne Business SchoolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/502932015-11-18T05:29:20Z2015-11-18T05:29:20ZFinancial markets are almost off cigarettes – will they now kick the oil habit?<figure><img src="https://images.theconversation.com/files/102162/original/image-20151117-22201-o1d6o8.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Loosening their grip. Will markets exit oil like they edged away from tobacco?</span> <span class="attribution"><a class="source" href="http://www.shutterstock.com/s/dirty+old+man/search.html?page=1&inline=152716115">From www.shutterstock.com</a></span></figcaption></figure><p>Are oil and gas companies going the way of big tobacco? Not soon, it would seem. The UK stock market counts Royal Dutch Shell and BP <a href="http://www.stockchallenge.co.uk/ftse.php">in its top five stocks</a> by market value. In the US, <a href="http://www.huffingtonpost.com/news/apple-vs-exxon/">Exxon vies with Apple</a> for the top slot. But as campaigns persuading investors to sell fossil fuel holdings, land glancing – if not, killer – blows, it is worth considering their managed decline.</p>
<p>Oil divestment programmes form part of the socially responsible investment (SRI) sector which foregoes potentially profitable investment opportunities for the social good. Even if there are convincing arguments about the long-term sustainability of business models and profits, it’s a tough sell.</p>
<p>Simply put, reducing the capital base for fossil fuel and CO₂ emissions by changing investment behaviour is a goal which bumps up against the financial imperative that drives investment decisions.</p>
<p>So how has socially responsible investment impacted investment markets? To answer that, look back over the past half century to another industry that was shunned by funds before the CO₂ debate.</p>
<p>In the 1960s it became clear that tobacco consumption was harmful to health and a steady barrage of medical evidence, coupled with <a href="http://www.stateoftobaccocontrol.org/tobacco-timeline.html?referrer=https://www.google.co.uk/">restrictions</a> and increasingly punitive <a href="https://en.wikipedia.org/wiki/Tobacco_politics">law suits</a>, forced many investors to reconsider their holdings. Tobacco, together with alcohol and gambling, were named “sin stocks” – a <a href="http://www.usatoday.com/story/money/markets/2015/05/25/motley-fool-sin-stocks/22472569/">malign alternative to their do-gooding peers</a>.</p>
<p>We can track the consequences of SRI developments on the tobacco sector. Firstly, the impact of declining output and lawsuits caused good performance from the 1970s to reverse. The chart below shows that for $100 in tobacco (red) with all income re-invested since 1973, a peak of almost $10,000 was achieved by the late 1990s, before a late reaction to the deluge of negativity forced a correction. Outperformance relative to the overall market (blue) was eroded by 2000.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/102159/original/image-20151117-4983-1adlm0b.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/102159/original/image-20151117-4983-1adlm0b.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/102159/original/image-20151117-4983-1adlm0b.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=372&fit=crop&dpr=1 600w, https://images.theconversation.com/files/102159/original/image-20151117-4983-1adlm0b.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=372&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/102159/original/image-20151117-4983-1adlm0b.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=372&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/102159/original/image-20151117-4983-1adlm0b.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=467&fit=crop&dpr=1 754w, https://images.theconversation.com/files/102159/original/image-20151117-4983-1adlm0b.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=467&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/102159/original/image-20151117-4983-1adlm0b.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=467&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Recovering tobacco.</span>
<span class="attribution"><a class="source" href="https://forms.thomsonreuters.com/datastream/">Datastream Total Return Indices</a>, <span class="license">Author provided</span></span>
</figcaption>
</figure>
<h2>Responsibility</h2>
<p>Why was an industry subject to punitive legislation and massive legal bills so resilient? The answer might be a clue for the fate of contemporary oil companies.</p>
<p>Concerns were raised over fund managers’ responsibility to deliver returns for their clients. Tobacco giants <a href="http://www.ncbi.nlm.nih.gov/pmc/articles/P">argued</a> that while their stocks offered high earnings fund managers had a duty to clients (often small pension fund holders like you and me) not to divest and to support new plans. But that relies on these accursed “sin stocks” delivering returns strong enough to outweigh ethical arguments.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/102164/original/image-20151117-30404-pcijgs.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/102164/original/image-20151117-30404-pcijgs.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/102164/original/image-20151117-30404-pcijgs.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=338&fit=crop&dpr=1 600w, https://images.theconversation.com/files/102164/original/image-20151117-30404-pcijgs.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=338&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/102164/original/image-20151117-30404-pcijgs.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=338&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/102164/original/image-20151117-30404-pcijgs.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=424&fit=crop&dpr=1 754w, https://images.theconversation.com/files/102164/original/image-20151117-30404-pcijgs.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=424&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/102164/original/image-20151117-30404-pcijgs.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=424&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Lighting up the index.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/my-cutout/2427276258/in/photolist-4GuqEE-4msefF-cAdHVN-29jZWX-9gP9f-hSo34H-nRai54-m3ky8x-5c3xJz-eC5dXD-bCYepp-927bRT-8VKGCw-6prKFG-ByXGa-aPJiY6-poob6R-5bPkpH-4xyMDn-KAs5Q-b1E4eM-aCmoj9-76bSKt-4b1hQC-4tgs4L-ahbVPW-4Cz8Q5-9tWpCX-s6dFt4-4FJKVh-4xyMF6-86wUKf-vt1xDP-5bTBim-4RfiwJ-4xyMEc-4xyMAt-4xCXNS-aixqy8-a2vy3e-dHhBe5-4715GC-76bT6X-aa63H9-63btDv-auQEps-ahbVQG-5XUGQQ-PntwA-qJqaao">Ximena Salazar</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span>
</figcaption>
</figure>
<p>When tobacco stocks were shunned by several large funds in 2000, <a href="http://pages.stern.nyu.edu/%7Esternfin/mkacperc/public_html/sin.pdf">research</a> shows a 15-20% “SRI markdown”. But once that was completed, we see excess performance of about 3% a year since, in other words: beating the market. In fact, had you held on to that $100 tobacco stake from 1973, and re-invested all dividends, it would now be worth nearly $100,000. This performance is due to high payouts and relative stability since that late 1990s blip. The industry <a href="http://www.who.int/trade/glossary/story089/en/">doesn’t seem short of issues</a> that might motivate more investors to withdraw, but until those issues bite decisively, big tobacco has found <a href="https://epianalysis.wordpress.com/2011/11/14/tobaccosales/">success though globalisation</a> to keep its head above water.</p>
<h2>Oil well?</h2>
<p>But it hasn’t been all roses for the cigarette peddlars, despite their apparent resilience. Investors are simply not funding growth and expansion – they take their annual dividends and run. As a result, the industry’s share of the stock is falling. This indicates a dying sector – while it is still generating and paying high earnings, the tobacco corner is smaller now.</p>
<p>Only growth can support a niche play but tobacco’s capitalisation has declined from its peak and faces further SRI exclusion. In the S&P 500 index of top stocks in the US, three firms remain, with an index share of 1% (Philip Morris, Altria and Reynolds). Believing these will become less significant, managers that are focused on future growth have sold to dividend-seeking income funds. </p>
<p>If this is tobacco’s fate, can oil be next? The harms of conflict, pollution and climate change certainly have the potential to increase social costs and put future returns at risk. However, oil and gas investments are a much bigger fish to fry than tobacco. At their peak they accounted for 25% of market capitalisation, this has fallen but is still 10%. Moreover there are currently <a href="https://en.wikipedia.org/wiki/List_of_S%26P_500_companies">40 oil and gas</a> in the S&P list of America’s biggest stocks.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/102167/original/image-20151117-22432-aqwia0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/102167/original/image-20151117-22432-aqwia0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/102167/original/image-20151117-22432-aqwia0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=407&fit=crop&dpr=1 600w, https://images.theconversation.com/files/102167/original/image-20151117-22432-aqwia0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=407&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/102167/original/image-20151117-22432-aqwia0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=407&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/102167/original/image-20151117-22432-aqwia0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=512&fit=crop&dpr=1 754w, https://images.theconversation.com/files/102167/original/image-20151117-22432-aqwia0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=512&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/102167/original/image-20151117-22432-aqwia0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=512&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Rigged game. Murky future for oil stocks.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/stignygaard/3002902143/in/photolist-5zmEbT-qVJush-7ZcU2P-xoL6DG-qXEMfa-2BwAeD-dRuHpj-5PuWw1-6htWco-6Jmyv-5thxx4-rCJJcT-qVHJwj-muATX-bXhiYh-6Jmzu-71K9Q8-wHSCbR-rUZHf9-3t45f-cj2RnA-pTYDkb-HwKAd-34N5tH-4kSi5a-aQaLwt-esR4Ss-yKY4Se-r14Lc5-6trCak-9YTrqE-rufn6B-fCePGx-34N5tn-4HiZJQ-cdjURq-XaaqA-rCJEsD-8Eiz5y-bxeLor-gHXVUG-xBoj37-9kfA6B-aF3BRB-mNynP6-dYzzVT-iwkGaE-btDbD1-d28fvW-4kWmGm">Stig Nygaard</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>Unlike tobacco, oil and gas will necessarily remain a significant part of asset allocation – and index funds have no choice but to match. Choosing to put less tobacco stocks in a portfolio than are in the market is no longer risky, but under-weighting oil is. Since 2000, US oil and gas stocks have also outperformed (green in the chart above, with a dip of late) but oil will take time to replace.</p>
<h2>Taking the hard road</h2>
<p>So let’s say the managers running our money can’t be convinced to sell oil giants yet. It doesn’t mean they are entirely without influence. <a href="http://rfs.oxfordjournals.org/content/early/2015/09/07/rfs.hhv044.abstract">Active ownership</a> allows asset managers to flag concerns and ask for governance or sustainability action.</p>
<p>Crucially, energy companies can chose to embrace green generation technology or not and fund managers will have a say in those decisions. The risk of CEOs talking without acting or, like VW, <a href="https://theconversation.com/lessons-from-vw-courage-climate-change-and-the-c-suite-47969">failing to spot flaws in their business</a> is severe reputational damage.</p>
<p>Tobacco signals a likely future for oil companies that struggle to change tack. Even if funds don’t divest, high dividends won’t persuade them to re-invest. Oil assets face becoming <a href="http://www.carbontracker.org/report/wasted-capital-and-stranded-assets/">stranded</a>, luring investors with high yield but low growth. Like tobacco, oil will fade from the index. No one wants to be the one turning the lights out; no fund wants to be the last selling out.</p><img src="https://counter.theconversation.com/content/50293/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Mark Shackleton does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Efforts to break our financial addiction to the energy sector might find useful lessons in the slow decline of tobacco.Mark Shackleton, Professor of Finance, Associate Dean Postgraduate Studies, Lancaster UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/464032015-08-23T19:47:11Z2015-08-23T19:47:11ZAustralia’s appetite for dividends could cannibalise economic growth<p>As another corporate reporting season in Australia draws to a close, the broad trend has been moderately underwhelming earnings results, combined with a rise in the earnings repaid to shareholders in the form of a dividend.</p>
<p>During this recent reporting period Australian firms returned, on average, 73% of their profits to shareholders as a dividend. This leaves only 27% of profits available to be retained in the firm to fund future growth.</p>
<p>As shown in the chart below, the ratio of profits paid out as dividends has increased in Australia from approximately 60% in 2005 to the current value of 73%. This result mirrors a recent international trend, however Australian firms continue to have high dividend payout ratios by international standards. The average firm around the world currently only returns 44% of profits to shareholders.</p>
<iframe src="https://charts.datawrapper.de/MWwCM/index.html" frameborder="0" allowtransparency="true" allowfullscreen="allowfullscreen" webkitallowfullscreen="webkitallowfullscreen" mozallowfullscreen="mozallowfullscreen" oallowfullscreen="oallowfullscreen" msallowfullscreen="msallowfullscreen" width="100%" height="400"></iframe>
<p>While many retail investors enjoy the regular revenue stream provided by the high yielding Australian equity market, this increasing trend in dividend payout ratios implies that dividends have consistently been growing at a faster rate than earnings; a phenomena that is not sustainable in the long-run and comes at the cost of economic growth.</p>
<h2>A taxing issue</h2>
<p>The large proportion of profits paid by Australian firms can largely be attributed to the imputation tax system, which was introduced in 1987 as a means of removing the double taxation of dividends. It allows companies to provide investors with a rebate for company tax that has been paid in the form of a franking credit attached to dividends.</p>
<p>Dividend imputation has achieved its intended aim of reducing the leverage of Australian firms. It’s an incentive for the use of equity rather than debt finance. Under the previous tax system, debt was more attractive than equity finance, resulting in the Australian economy having a large exposure to financial risk given the highly levered nature of many firms. </p>
<p>However, this reduction in financial risk has come at the cost of significant under-investment in the non-mining sectors of the Australian economy. The increased demand for dividends within an imputation tax system restricts firms’ access to their preferred source of financing: retained earnings. </p>
<p>The reinvestment of retained earnings creates multiplier effects that have a greater positive impact on the economy compared with dividends in the hands of individual shareholders. By retaining less of their earnings and under-investing compared with international counterparts, <a href="http://www.afr.com/news/economy/why-australian-firms-are-spurning-the-rbas-rate-cuts-20150618-ghr997">Australian firms run the risk of lagging behind</a>.</p>
<h2>Time for a policy fix?</h2>
<p>Given the Australian government is currently focused on <a href="http://www.businessinsider.com.au/heres-treasurer-joe-hockeys-2015-federal-budget-speech-2015-5">driving investment and growth in the non-mining sectors</a> as the key mechanism for improving the current fiscal imbalance, consideration may have to be given to the future efficacy of the imputation tax system and the incentives it creates for large dividend payouts. </p>
<p>The imputation tax system is less relevant today than it was in 1987, given the increased integration between global markets and the growing reliance on international funding. As the tax benefits of the imputation tax system can only be accessed by Australian taxpayers, it creates a bias in favour of domestic investors. </p>
<p>For domestic superannuation funds with a marginal tax rate close to zero, the imputation tax system means they pay little, if any, tax on dividends, creating a big incentive for over-exposure to domestic equities. Given the structural changes that have occurred since 1987, the recent Financial System Inquiry noted that “<a href="http://fsi.gov.au/publications/final-report/appendix-2/">the case for retaining dividend imputation is less clear than in the past</a>”.</p>
<p>An alternative tax system that does not impose double taxation on investors while potentially reducing the current handbrake on economic growth is Singapore’s one-tier tax system. Under this system, profits are only taxed once at the corporate level. In Singapore dividends and capital gains are <a href="http://www.mof.gov.sg/MOF-For/Businesses/One-Tier-System">tax exempt</a>. This simplified tax system reduces compliance costs and would ease the domestic investors’ current demand for dividends, and their associated franking credits, to be paid out.</p>
<p>Regardless of any taxation reform, investors need to be mindful that they can’t have their cake and eat it too with respect to dividends. The current trend of increasing the proportion of profits paid as dividends is not sustainable and has the potential to impede Australia’s long-run economic growth.</p><img src="https://counter.theconversation.com/content/46403/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Paul Docherty receives funding from Platypus Asset Management.</span></em></p>Australian companies are paying more of their profits out as dividends, and if it continues it will hurt our economy.Paul Docherty, Senior Lecturer, Newcastle Business School, University of NewcastleLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/198752013-11-07T19:39:21Z2013-11-07T19:39:21ZBank profits grow, and so does the criticism. Who’s right?<figure><img src="https://images.theconversation.com/files/34480/original/8cd8mc8g-1383699965.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Commonwealth Bank chief Ian Narev announces a record full-year profit of A$7.8 billion, ahead of this week's $2.1 billion quarterly result.</span> <span class="attribution"><span class="source">Paul Miller/AAP</span></span></figcaption></figure><p>Like most companies, banks report their profits twice a year. Each time the majors report we see headlines about the size of the profits and implicit or explicit criticism of the amount – this time about A$27 billion.</p>
<p>The banks usually respond by pointing out absolute profit is not really the issue: as big companies, the dollar value of profit, revenue, assets, employment and investment will always be large. They suggest it makes more sense to ask whether their return on equity and their return on assets are reasonable. And using these criteria, ones we normally use to assess corporate profitability, the bank profits do not look excessive. There are many other listed Australian companies that are more profitable per unit of equity, and while the Australian banks do better than many banks in Europe or the USA, that is hardly accepted as a relevant benchmark these days.</p>
<p>The second argument put by the banks is that they pay about 70% of their profits out as dividends, much of which goes to augment the superannuation returns of most Australians. The fundamental point is that Australian banks are (mainly) owned by ordinary Australians, either directly or indirectly, so a wide range of Australians benefit from the profits earned either through dividends or higher share prices.</p>
<h2>Dividend warning</h2>
<p>This high rate of dividend pay-out has attracted some <a href="http://www.smh.com.au/business/banking-and-finance/banks-told-to-limit-their-dividends-20131031-2wi0e.html">criticism</a> recently. The regulator (APRA) has questioned whether the banks are paying out too much of their profit and should instead be keeping more in reserve to deal with future risks. Interestingly this is not an argument about excessive profits, but about the distribution of the profits.</p>
<p>There has also been some recent comment that the level of profit is not sustainable. Analysts have <a href="http://www.afr.com/p/business/financial_services/debt_reserve_cuts_raise_doubts_over_yT9SHo7VL8qWjyg4VeytbP">pointed out</a> that banks are holding fewer reserves against lending risks than they have in the past, and warn banks may have to increase their reserves if business or household lending risks were to rise. This is pointing out that bank profits go up and down with the business cycle, again not directly challenging the level of profits, although it may be suggesting that we are at a peak.</p>
<p>Part of the reason banks attract so much attention, for example compared to the very profitable mining sector, is that their business is mainly domestic. If they are making too much profit, it must be because they are charging us too much. There is very little evidence of this: Australian banks have interest margins which are about average by international standards.</p>
<h2>Comfortable oligopoly?</h2>
<p>The other standard line of criticism of the major banks is that they constitute an oligopoly which controls the market as a collective. This is much more difficult to assess and any co-ordinated, anti-competitive behaviour by such a collective would be illegal and subject to action from the Australian Competition and Consumer Commission. One of the reasons the banks can appear to act in concert is that they all have very similar business models so their borrowing costs and lending risks rise at the same time and by similar amounts, so their price changes tend to be similar.</p>
<p>Any analysis would need to be careful since there are many financial markets – credit cards, investment banking, broking, wealth management, insurance etc – where even collectively the banks are not dominant.</p>
<p>Most critics point to the mortgage market as being the main area of concern. The four major banks manufacture over 80% of all mortgages. They actually retail a much smaller percentage as the mortgage brokers sell a significant number, around 40%, and actively market the fact in direct opposition to the bank’s own sales channels. But even there we have seen the banks (notably NAB) competing aggressively on price, and entrants like Macquarie pushing aggressively into the market.</p>
<p>So yes, the profits of the banks are large. This mainly reflects the size of the businesses rather than obviously excessive profitability, and regulators, rising risks and increased competition may cut into the profits in future.</p><img src="https://counter.theconversation.com/content/19875/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rodney Maddock does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Like most companies, banks report their profits twice a year. Each time the majors report we see headlines about the size of the profits and implicit or explicit criticism of the amount – this time about…Rodney Maddock, Vice Chancellor's Fellow at Victoria University and Adjunct Professor of Economics, Monash UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/151362013-06-25T21:00:38Z2013-06-25T21:00:38ZA frank debate - dividend washing and double dipping<figure><img src="https://images.theconversation.com/files/25934/original/9yzgv2q2-1371712844.jpg?ixlib=rb-1.1.0&rect=0%2C2%2C1000%2C850&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Dividend washing enables some domestic investors to essentially gain a dividend “twice”.</span> <span class="attribution"><span class="source">Image sourced from www.shutterstock.com</span></span></figcaption></figure><p>There is currently considerable interest in the practice of “dividend washing”. This refers to the practice of investors being able to trade shares cum-dividend for a period after the ex-dividend date has passed, under special arrangements provided by the ASX. </p>
<p>It is suggested that some investors are “double dipping” into the pool of franking credits distributed with dividends, by selling shares they hold once they go ex-dividend and then buying replacement new shares in that special trading, which they receive cum-dividend. </p>
<p>They get, for example, dividends (and attached franking credits) on 2000 shares despite only owning 1000 shares at any point in time. If foreign investors are selling the shares, there is a cost to tax revenue because they would have been unable to use the franking credits attached to the dividend.</p>
<p>The issue of dividend washing can be addressed in three steps. First, should the practice be permitted? Second, why might cum-dividend trading be allowed after the ex-dividend date? Third, if the rationale for allowing such trading reflects current institutional arrangements, is there some simple adjustment to those arrangements, which is a superior solution to others proposed?</p>
<p>It is clear that dividend washing is at variance with the objective of preventing trading in imputation credits, which transfers those credits from those unable to use the tax benefits (foreign investors) to domestic investors. Dividend washing also enables some domestic investors to essentially gain a dividend “twice” by selling their current stock holding ex-div and then buying cum-div in that period of trading permitted by the ASX after the ex-div date. </p>
<p>But this is only a cost to government tax revenue if it increases the total amount of sales of cum-dividend stock by foreigners. It may be simply a redistribution of the timing of cum-div sales by foreigners from before the ex-div date to this later period. That is an empirical question.</p>
<p>Cum-dividend trading after the ex-dividend date arises because of the institutional arrangements associated with trading of equity options on the ASX. Specifically: </p>
<ul>
<li> writers of call options are required to deliver stocks if
options are exercised against them </li>
<li> buyers of call options might exercise an option on the last<br>
cum-dividend day</li>
<li> the allocation of exercised options against writers (in the event that less
than 100% of outstanding options are exercised) is done randomly because of
novation</li>
<li> that process occurs overnight, so option writers will not know they
have been exercised against and need to deliver stocks until the
ex-dividend day. </li>
</ul>
<p>Consequently, the stocks they are required to buy to deliver (if they are not hedged by already holding such stocks), will not have dividends attached, whereas the option holder is entitled to receive stocks with the dividend attached. By allowing a short period of cum-dividend trading after the ex-dividend date, this problem is resolved – but creates the opportunity for dividend-washing transactions unrelated to option trading.</p>
<p>The first point to note, is that the reason for allowing cum-dividend trading is unrelated to the issue of franking-credit use. If the same institutional arrangements for options trading and settlement existed in a market without dividend imputation, the same issue would apply. The option writer would still face the problem of being exercised against and not being able to buy shares with the dividend attached.</p>
<p>Therefore, there are two pieces of empirical evidence that are worth examining. First, is there any evidence of cum-dividend trading being greater for stocks paying franked dividends than stocks paying unfranked dividends in Australia? If so, this may suggest that cum-dividend trading is being requested primarily for trading of franking credits. Second, do similar arrangements for cum-dividend trading apply in overseas markets? If not, perhaps there are alternative institutional arrangements for options trading that obviate the need for allowing cum-dividend trading.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/25955/original/mtfw3md2-1371776222.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/25955/original/mtfw3md2-1371776222.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=450&fit=crop&dpr=1 600w, https://images.theconversation.com/files/25955/original/mtfw3md2-1371776222.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=450&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/25955/original/mtfw3md2-1371776222.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=450&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/25955/original/mtfw3md2-1371776222.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=566&fit=crop&dpr=1 754w, https://images.theconversation.com/files/25955/original/mtfw3md2-1371776222.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=566&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/25955/original/mtfw3md2-1371776222.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=566&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Cum-dividend trading after the ex-dividend date occurs under ASX special arrangements.</span>
<span class="attribution"><span class="source">Image source from www.shutterstock.com</span></span>
</figcaption>
</figure>
<p>What other institutional arrangements for options trading could be considered, which would obviate the need for cum-dividend trading?</p>
<p>One arrangement would be to allow settlement of options contracts in cash rather than requiring physical delivery. Then an option writer exercised against would be liable to pay the cash amount equal to the difference between the strike price and market price at the time of exercise, plus the grossed-up value of the dividend. (The grossed-up amount is the cash dividend plus the amount of the franking credit.) They would not have to buy stock cum-dividend.</p>
<p>An alternative approach would be to rewrite the option contract terms so the option holder would be entitled to receive the share cum-dividend only if the exercise occurred one or two days prior to the last cum-dividend date. This would provide the option writer with time to purchase the stock cum-dividend for delivery. Traders would need to know which was the key date one or two days prior to the last cum-dividend date and this may make arrangements for option trading slightly more complicated. However, option traders are expected to be financially sophisticated enough that this should not be a major issue.</p>
<p>Alternatively, if physical delivery is the only option, and a rewriting of the exercise conditions is not made, it would be possible to make a simple amendment to the tax laws to prevent dividend washing. Specifically, there would be a requirement that purchasers of shares cum-dividend after the ex-dividend date are not entitled to claim the franking credits. They would be able to deliver the shares cum dividend, inclusive of franking credits, in settlement of option obligations to option holders.</p>
<p>That approach might appear to give rise to dividend-washing opportunities by an investor buying both stock and call options in the same stock at least 45 days prior to the ex-dividend day. The strategy would be to exercise the options on the last cum-dividend day (prior to the ex-div day) and sell the stock already held on the ex-div day (using the proceeds to make the payment required on exercise of the call option). The investor would appear to be entitled to receive the dividend and franking credits on the stock and would then also receive the dividend and franking credits on the stock received from exercise of the call options. </p>
<p>However, the last-in-first-out rule would preclude this, as long as the date of purchase for the shares due from the call option is the date-of-option exercise (rather than delivery date). Those shares would then be deemed the ones sold on the ex-dividend day, and thus held for less than 45 days, precluding use of the franking credits attached to the dividend.</p>
<p>To the extent that particular institutional arrangements for ASX option trading give rise to the problem of dividend washing, it is perhaps appropriate to examine whether those arrangements can be changed in a simple manner.</p><img src="https://counter.theconversation.com/content/15136/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>I am a shareholder in the ASX.</span></em></p>There is currently considerable interest in the practice of “dividend washing”. This refers to the practice of investors being able to trade shares cum-dividend for a period after the ex-dividend date…Kevin Davis, Research Director, Australian Centre for Financial Studies Licensed as Creative Commons – attribution, no derivatives.