Are Dividends Fair?
The left hand side of the balance sheet represents the resources or investments of the firm. The right hand side of the balance sheet represents the claims against the resources or the”investors” in those resources.The investments (left side) must be equal to the investors (right side); the resources must be equal to the claims against the resources.
The claimants often consist of various classes of debt and/or equity interests, including suppliers of goods and services,bankers, bondholders, preferred stockholders, and common stockholders.
Dividends are a liquidation of the firm’s cash resource, but this repatriation of the firm’s resource is made to just one class of resource claimants –the common shareholder. Is this fair? Don’t all right side of the balance sheet folks have an interest in the left side resources of the firm?
The payment of common stock dividends reduces the firm’s value by the amount of cash paid to shareholders via the dividend,but the reduction in value affects all right side of the balance sheet providers of capital. So, debt holders lose value even though they don’t get a dime of the dividend. This just doesn’t seem fair, does it?
…no wonder they call it the “dividend puzzle”.
Posted on Tue, March 30, 2010
by Timothy E. Moffit