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Dividends: the evidence

attract institutional investors, many of which are tax exempt (life insurance funds,

pension funds and the like). Institutions, because they tend to be large investors and

are professionally managed, tend to take steps to try to ensure that the businesses in

which they invest are well managed. The various studies on the clientele effect

broadly seem to support its existence.

Corporate taxes

A study by Siddiqi (1995) showed, as might be expected, that changes in tax rules that

make dividends less costly to businesses tend to be related to increased dividends.

Cash flow and investment opportunities

Barclay, Smith and Watts (1995) found, based on a sample of US businesses, that

dividends tend to be lower when there are more investment opportunities for the

businesses, as the MM principles would suggest.

Examples of real businesses following the MM principles

The high street retailer Monsoon plclast paid a dividend in 2003, despite being

profitable for every subsequent year since up to the time of writing. In Its 2004 annual

report the business said: ‘it is unlikely that the Group will pay dividends in future

years while it remains in a period of high capital expenditure’.

Michael O’Leary, the colourfully spoken chief executive of the ‘no-frills’ airline

Ryanair Holdings plc, was rather more direct than Monsoon plc. He said: ‘We are

never paying a dividend as long as I live and breathe and as long as I’m the largest

shareholder. If you are stupid enough to invest in an airline for its dividend flow you

should be put back in the loony bin where you came from’ (Osborne 2004). More

diplomatically, the business’s website says: ‘Ryanair Holdings anticipates, for the fore-

seeable future, that it will retain any future earnings in order to fund the business

operations of the company, including the acquisition of additional aircraft needed for

Ryanair’s planned entry into new markets and its expansion of its existing service, as

well as replacement aircraft for its current fleet.’

EMI Group plcsaid in its 2007 annual report that it would not be paying a dividend

for the year because it needed funds to restructure the business.

These are three examples of businesses that seem to be following the MM approach.

It must be said that such businesses seem to be in the minority. Most businesses do not

see the dividend as what is left over when investment needs have been exhausted.

Examples of real businesses not apparently following the MM principles

Many businesses seem to base their dividends on the profit of the most recent account-

ing year, though with reference to future investment. For example, the UK telecom-

munications business BT Group plcsaid in its 2007 annual report: ‘our proposed full

year dividend is 15.1 pence per share, 27% higher than last year, moving to a two-

thirds payout a year earlier than we had previously announced. We expect to increase

the dividend, taking into account our earnings growth, cash generation and our ongo-

ing investment needs.’ Paying out two-thirds of its profit as a dividend is the busi-

ness’s stated target.