Question

Post financial crisis period or post oil/commodities bust period that began couple of years ago, many Blue Chip companies, including many banks and oil and mining companies that were once considered the staple of dividend distribution, announced dramatic cutbacks in dividends. As expected, the markets punished these stocks severely and many of these companies that have not returned to their former dividend policies (with some recent rise in dividend levels for U.S. bank) operate with depressed stock prices.

Your post should answer the following question: do you believe that these companies’ dividend cuts, especially the ones in the banking sector, is a direct outcome of classic financial forecasting that is showing a dark future for many years to come or do you believe that these decisions are more short-term reflecting the current extraordinary economic environment? Do you agree these companies have made the right move considering the punishment their stock price has suffered by the hand of investors? What other examples of companies with significant dividend distribution policy changes you can think about?

Answer 1

I do believe that the decisions by banks and other related firms to cut their dividends are more short-term reflecting the current extraordinary economic environment and not a direct outcome of classic financial forecasting that is showing a dark future for many years to come. This is because cutting or reducing the dividends does not automatically mean that banking sector would perform poorly in terms of finances in future rather it depends more on the current financial situation in the environment. Cutting dividends might one way of trying to rescue the banking sector depending on the dark side that has been forecasted. Besides that, the signaling effect is not only negative but positive as well. When firms reduce dividends, it also sends a positive signal to the investors that the company has new projects to invest the retained earning which will produce more returns in future rather than giving out the earning at the present moment as dividends. Therefore cutting dividends in the banking sector can be associated with the current financial problem facing the sector which is expected to be short term.

Considering the punishment the company’s stock prices has suffered by the hand of investors, I do believe these companies have made the right move to cut the dividends. It is better to experience little losses now and gain more in future than gaining little now and suffer severe losses in future. What the banks are doing is just trying to hedge themselves against the forecasted losses they might experience in future. Probably according to the forecasts, letting the stock prices suffer in the hands of the investors at the moment is the best option aimed at protecting the sector from collapsing in future. For instances, if the banks are cutting dividends so as to control the money supply in the economy, then the whole process will save the nations from inflation.

Apart from the banking sector, investment and insurance firms are other companies I can think about with significant dividend distribution policy. Even though these companies operate in different sectors firms, they operate in more similar way like the banks. For instance they provide lending services at a stipulated interest rate just like banks do. Beside that these firms depending on similar factor of banks to run their operation. These factors are like exchange rates, interest rate, money supply and demand. Therefore if these are the factors forcing the banks to reach a decision of cutting off the dividends, then I do believe companies in the insurance and investment will reach a similar conclusion hence adopting dividend distribution similar to that adopted by the banking sector.