BP will suspend dividends! So what?

Posted by Marc Hodak on June 17, 2010 under Economics | 2 Comments to Read

A new symptom of financial illiteracy has been revealed by the obsession with BP’s dividends shown by politicians and the media, no doubt reflecting their readers’ sensibilities. The narrative is that BP’s shareholders should share in the suffering their company has caused by having their dividends suspended.

This attitude reflects what can only be called a pre-war (WWII) view of financial economics, an alternate world where the breakthrough insights of John Burr Williams or the Nobel Prize winning theories of Miller or Modigliani or the resulting empirical transformation of modern finance theory never happened.

On an intuitive level, it doesn’t matter to the owner of a gas station if their cash is in the till at the office or their cookie jar at home. Why would it matter to the shareholders if their cash is still inside the company supporting their share price or mailed out to them in the form of a dividend check?

Of course, the answer is it doesn’t matter.

What matters is the degree to which the current and future cash of the company must be devoted to cleaning up the mess that BP created, which is a separate consideration from what happens to the remaining cash. BP’s shareholders are already aware that the mess will be very costly, and the company has not shied away from acknowledging that cost. That is why the company’s stock price has lost half its value since the rig explosion.

The one sense in which dividends might matter is the result of the U.S. government’s dividend policy, i.e., it will be subjecting dividends received by all U.S. shareholders to much higher tax rates than the rates on capital gains starting next year.

That means corporate owners will actually prefer that the money be kept inside the company so they can realize their gains in a higher share price rather than via more cash paid out in dividends. So, starting later this year, many companies will be looking for an excuse to cut their dividends. BP has the perfect, if unfortunate, excuse for an early implementation of a dividend policy which will eventually become widespread, and share prices will end up rising faster as a result.

If the “penalize the shareholders” narrative had any validity, BP stock price should drop this morning at the open. I would bet that BP’s stock price will not budge to this non-story, and might even bump up, thanks to Obama’s dividend policy.

Robert S, Siegel said,

The simple issue with the BP dividend is that BP has violated property and other rights through this accident. BP must make good – they must make everyone whole for the damage that they have done and continue to do. At this point, we can not know the extent of that damage and therefore the cost.

BP’s shareholders own the company. Therefore, they are responsible for the damage done by the business that they own.

If the U.S. government acts within their role, they should be judge and enforcer of law. The government should be able to insist that BP’s owners build up sufficient cash reserves to pay claims against the company. Therefore, dividends, i.e. distribution of profit to the business owners, should be withheld.

Yes, I know that our regulatory environment caused BP to drill offshore in dangerous waters. Regulations too often cause far more damage than they alleviate and this is a perfect example. However, BP made the decision to take on the challenge of drilling in those deep waters. They made claims that they could handle this project safely and profitably. They knew the rules and they knew the challenges yet they took the risks and in the process, they hurt others. They failed to Mind Their Own Damn Business by using their drive for profit to hurt others ability to earn their livings. BP’s owners must pay and the federal government as judge and enforcer must ensure that BP does not shirk its responsibility.
Marc Hodak said,

Robert,

Thanks for your comment. The point wasn’t that BP is not responsible for damages–it surely is. It has accepted responsibility, and has the resources to make good on it, regardless of their dividend policy.

In fact, the U.S. government is not acting within its role. The executive branch acting as “judge and enforcer” is clearly stepping beyond its role. We have a judicial process for determining who is entitled to what damages, a process that an impatient executive has succeeded in skirting using raw political power.