By Georges Ugeux on The Capital
As the government is proactively trying to prevent companies from failing, cash payments to shareholders under the form of dividends or buybacks should be prohibited in 2020.
I am only talking about listed companies because they include massively large companies. The S&P 500 represents 70–80% of the market capitalization of US stocks, more than $20 trillion. In this index, ten companies alone represent 25% of the total S&P 500 market capitalization.
The pandemic sweeping the world will turn global economic growth “sharply negative” in 2020, triggering the worst fallout since the 1930s. The growth forecasts announced this month by the IMF are unambiguous: it is the largest crisis since the 1930s, and the US might see its GDP decrease by 5.9%. Yet their forecast rebound in 2021 is based is hard to predict, including the pathway of the pandemic, the intensity and efficacy of containment efforts, the extent of supply disruptions, the repercussions of the dramatic tightening in global financial market conditions, shifts in spending patterns, behavioral changes (such as people avoiding shopping malls and public transportation), confidence effects, and volatile commodity prices. Many countries face a multi-layered crisis comprising a health shock, domestic economic disruptions, plummeting external demand, capital flow reversals, and a collapse in commodity prices. Risks of a worse outcome predominate.
Bankers at JP Morgan understand what lies ahead. The reduction of its earnings for the first quarter is due to a record provisioning of future non-performing loans from distressed companies. The bank added $6.8 billion to loan loss provisions. The reserve increase signals that management expects a surge in defaults across the company’s lending businesses, including credit cards, energy, real estate, and retail sector.
In addition to the excessive debt burden, the spread over U.S. treasuries has exploded (graph left). Looking That is threatening the ability of borrowers to add or refinance their debt.
No cash dividends in 2020: the $500 billion question
Rather than borrowing, companies should first and foremost keep the cash they have to survive this and probably next year without increasing their indebtedness. I am neither demonizing shareholders nor accusing them of the fragile financial structure of the U.S. corporate world. U.S. non-financial corporate debt of large companies now stands at about 10 trillion dollars, 48% of GDP. This represents a rise of 52% from its last peak the third quarter of 2008, when corporate debt was at $6.6 trillion, about 44% of 2008 GDP.
In 2019, they distributed $489 billion of dividends on the 2018 results. This number might exceed $ 500 billion in 2020. Let’s prohibit companies to pay those dividends in cash and offer only stock dividends. The impact would be fruitful:
· The companies would retain $500 billion of equity
· Their cash position will improve by $500 billion
· Since they would distribute their dividends in shares, it would not be equivalent to skip a year of dividend
Of course, shareholders might count on a cash payment: nothing would stop them from selling those additional shares in the market. The whole dividend distribution represents 2.5% of the total market capitalization.
No share buyback in 2020: the $1 trillion question
So, we, the taxpayers are going to bail out companies? The level of buybacks to free cash flow hit 104% for the 12 months ending in the first quarter of 2019, the first time that number has topped 100% during the economic recovery that started in 2009. In 2017, the level was 82%. Since 2012, the four largest airlines bought back a cumulative $45 billion of their shares — they are now standing in line for a bailout from the government.
In front of the uncertainties of the current market, the amount has been reduced by 25% this year.
The motivation of companies is not difficult to understand. The more than 10-year bull market has been largely supported by share buybacks. Companies have boosted share prices by buying back their own stocks. Not their earnings. They needed to recourse to debt to increase their share prices and pay their dividends…not to talk about the bonuses linked to the stock price.
In a CLS Blue Sky Blog, I argued for the SEC to impose the same disclosures for share buybacks as for increases of capital and IPOs. In April 2019, I wrote that share buybacks required more scrutiny. The capital increase of a listed company is accompanied by an underwriting process, due diligence, and justification of the board in a prospectus. Share buybacks deserve similar transparency and authorization requirements — perhaps more than under the current Rule 10B-18 regime that covers buybacks. The SEC was right to assess the wider implications of buybacks. Under a Republican majority, that initiative was not followed by any action.
The US new stimulus attempts to curb the abuses but still favors shareholders.
The recent $2 trillion CARES Act stimulus contains restrictions: no dividends, no buyback and a cap on remuneration of top executives. But it is limited to companies who decide to obtain a government bailout. Any company receiving a loan under the program is barred from making stock buybacks for the term of the loan plus one year.
Capital markets should be able to take care of the liquidity needed for stock dividends to be monetized through the stock market.
However, contrary to the bailouts of the 2008 crisis, they come under the form of loan instead of equity. Companies do not need to replace or add debt from the public sector rather than the financial institutions. They need equity, and that will provoke a penalty for shareholders: a massive dilution of their voting rights.
It is time for corporates to be creative and not wait to be told that their first duties are to their businesses and employees, that returning equity to shareholders in the form of buy back is a source of instability and that paying their dividends in the form of stock will avoid further leverage of the corporate sector.
Why shareholders of listed companies should not receive cash right now was originally published in The Capital on Medium, where people are continuing the conversation by highlighting and responding to this story.