http://www.nytimes.com/2008/10/21/opinion/21stein.html
The New York Times
October 21, 2008
Op-Ed Contributor
This Bailout Doesnt Pay Dividends
By DAVID S. SCHARFSTEIN and JEREMY C. STEIN
Cambridge, Mass.
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Although there are many things to like about the government's plan, the
failure to suspend dividends is not one of them. These dividends, if
they are paid at current levels, will redirect more than $25 billion of
the $125 billion to shareholders in the next year alone. Taxpayers have
been told that their money is required because of an urgent need to
rebuild bank capital, yet a significant fraction of this money will
wind up in shareholders' pockets -- and thus be unavailable to plug the
large capital hole on the banks' balance sheets.
Moreover, given their own equity stakes, the officers and directors of
the nine banks will be among the leading beneficiaries of the dividend
payout. We estimate that their personal take of the dividends will
amount to approximately $250 million in the first year.
Bank executives may argue that it is necessary for them to maintain
dividend payments to support their stock prices and to make further
capital-raising possible. This argument is dubious. In recent years,
the fraction of American public companies that pay dividends has fallen
drastically, to a level of around 20 percent. The ranks of the
companies that do not pay dividends include some of the most profitable
and (until recently) best-performing market darlings, like Google.
These companies have come to recognize what finance academics have been
preaching for decades: for financially healthy firms, there is no
particular imperative to pay dividends every quarter, because retained
cash can always be paid out to shareholders later, or used to
repurchase stock.
So why would the banks want to maintain large dividend payouts when
they've had such a hard time borrowing, are starved of cash, and the
credit markets believe that they run a significant risk of defaulting?
Shouldn't these distressed banks be marshalling all of the financial
resources available to them to ensure their viability?
Although dividends should be a matter of near indifference to
shareholders of healthy companies, when companies are financially
distressed there is a conflict of interest between shareholders and
bondholders that leads shareholders to prefer immediate payouts.
Here's why: Each dollar paid out as a dividend today is a dollar that
cannot be seized by creditors in the event of bankruptcy. For a
distressed company, dividends are not in the interest of the enterprise
as a whole (shareholders and lenders taken together), but only in the
interest of shareholders. They are an attempt by shareholders to beat
creditors out the door.
The government should close the door by putting an immediate stop to
the dividend payouts of any banks receiving direct federal support. The
purpose is not just to be fair or to avoid unsavory appearances, but to
improve the health of the banks and the economy.
There is ample precedent for such a move by the government. When
Chrysler was bailed out with government loan guarantees in 1979, the
legislation explicitly prohibited Chrysler from making any dividend
payments. All dividends on its common shares were suspended from 1980
to 1983.
If the government is unwilling to take this step, then the boards of
the banks should take it upon themselves to do the right thing. They
may even have a legal obligation to do so, because courts have ruled
that directors of financially distressed firms have a fiduciary duty to
creditors as well as to shareholders.
The creditors of the banks include not just those who have already lent
them money, but also American taxpayers who put their money on the line
by guaranteeing the banks' debts. From the perspective of this broader
set of stakeholders, it is best to end dividend payments until the
banks have returned to health.
David S. Scharfstein is a professor of finance at Harvard Business
School. Jeremy C. Stein is a professor of economics at Harvard.