How Bigger Dividends Build Trust
Financial Times, October 6, 2003
4 Pages Posted: 25 Nov 2003
Abstract
Microsoft recently doubled its dividend and will pay out about $1.7bn to shareholders of record on November 7. It joins 1,000 other US companies that have either instituted or increased dividends this year. While most observers have focused on the policy considerations that have sparked this trend - specifically the decrease in marginal tax rates on dividend income in the US - they have missed another, equally important, implication. Dividend policy remains a critical, yet often neglected, weapon in the battle to reduce agency costs. Agency costs arise when the interests of managers and the interests of shareholders diverge. Such tensions can arise on issues ranging from the nature and level of executive compensation to the rate at which executives reinvest profits.
While such divergence can play itself out dramatically, as in the case of Enron, it often manifests itself in far more mundane issues, such as whether a company should be predisposed to return funds to shareholders or predisposed to invest them in expanding the company. Dividend policy, although rarely viewed in this light, represents an important tool for those seeking to realign the incentives of managers with those of shareholders.
Keywords: Free cash flow, Agency costs, Reinvestment policy, governance
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