Breakthrough Idea? Do not pay dividends!

Reading time: 4 – 6 minutes

The Harvard Business Review of February 2007, featured a list of  ”Breakthrough Ideas for 2007″  that sheds light on the regard that US business executives and their mentors have for ordinary stockholders.

Why should I pay dividends?

Now, I wouldn’t ordinarily give much attention to an HBR article, but this featured piece claimed to be a  ”List of Breakthrough Ideas for 2007!” — deemed “provocative and important” by HBR editors — the result of ‘brainstorming’ seminars at the World Economic Forum and discussions among the high and mighty in Davos, Switzerland.

Eureka!

There is nothing like a proclaimed “breakthrough idea” to provide us with insights into the minds of those who would run the world.

Lots of Cash and No Brains!

Breakthrough Idea No. 8 (of the HBR list of 20) was entitled  ”Borrowing from the PE Playbook” and presented a solution for executives that, as a result of cost cutting and improved productivity, now had an embarrassing “mountain of cash”.

Here is how the case was framed:

“A cash mountain used to be considered a good thing — savings for a rainy day or a war chest for future acquisitions. Today, it’s a mixed blessing, and the possibilities for spending the cash wisely are much reduced. For one thing, profitably emptying a war chest isn’t as easy as it once was. Private equity firms are hunting for big corporate deals and using their financial leverage to bid up the prices of acquisition targets — effectively pricing ’strategic buyers’ out of the market.”

“But keeping the cash in the bank isn’t an option. Not only does it generate embarrassingly low returns for investors, but it can make a company more attractive to PE firms. … “

“Some companies resort to share repurchases, but these create value only if the company is undervalued by investors — which is the exception, not the rule.”

“Giving the cash back to shareholders in the form of dividends isn’t a very attractive alternative: It effectively signals that management has run out of promising new growth ideas, which will inevitably effect the share price.”

Huh? Hold it, right there!

Lets get this straight:

• A company is sitting on a “mountain of cash” and doesn’t know what to do with it.
• Stock prices are so high that buying other companies is not easy and equity repurchases are not justified.
• Management doesn’t have any idea what to do with the money, but doesn’t want shareholders to know.

Do Investors Despise Dividends?

It used to be — in olden times when common stocks were newly invented — that the whole purpose of buying stocks was to receive dividends when a company was profitable.

It would seem to me, as a humble investor, that a handsome dividend paid as the result of cost savings and productivity gains, would make management look good — at least to my eyes.

After all, dividends are the highest form of “return on investment” — the be-all-and-end-all of John Burr Williams’ formula for valuing equities.

But the Harvard Business Review says that dividends are not only not “attractive”, but that, according to the murky ethics of the Harvard Business School, executives should conceal from shareholders the fact that they’ve run out of ideas of what to do with shareholders’ money, and ought to hold on to it anyway.

Keep shareholders’ cash for yourself!

The author of *Breakthrough Idea No. 8* goes on to advocate that, rather than pay dividends to stockholders, the wise executive should gamble with the shareholder’s money, trying to buy other firms in an admittedly over-priced, highly competitive market in which management is said to have little experience!

The HBR article claims:

“Like it or not, acquisition really is the only option.”

Really? The only option? How about dividends that were so disparagingly dismissed?

I’m sure shareholders would prefer to receive their money than to have executives piss it away, trying to compete in an overheated acquisition market, about which they know little.

How about ethics and morals?

Is it right to keep shareholders’ money so they won’t guess that you don’t wake up each morning with a bright new idea of how to make a gazzillion dollars!

Yes, boys and girls, save your money and when you grow up, you too, like Jeff Skilling, can go to Harvard Business School and get your own shiny new “Breakthrough Idea”.