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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”.

2 comments (Add your own)

1. Brad Flaugher wrote:
Don’t equity holders do a service to the debt holders (via taking losses before they do) so if a company needs to pay a dividend to attract equity investors and keep them happy then it isn’t really “stealing”, right?

If the fundamental value of a stock is based on some expected future payout (dividend, liquidation) then in a world where its likely to receive 0% of an equity investment in the face of liquidation how does one justify the value of the stock, other than the potential earnings one would get from playing hot-potato with other suckers until the stock blows up.

Thu, January 12, 2012 @ 4:39 AM

2. Tim Moffit wrote:
Kyle Konwinski (facebook comment): “…thats the trade-off though right? common shareholders get paid (or don’t get paid) depending on the growth of the company. As opposed to preferred SHs who get paid with or without growth, and in addition, both preferred SHs and debt holders claims’ have priority to the common SHs.” http://www.facebook.com/?ref=home#!/profile.php?v=feed&story_fbid=105192636182754&id=40900710

Thu, January 12, 2012 @ 4:39 AM

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