Chapter 12 • The dividend decision
Many businesses seem keen to increase their dividends in a steady, sustainable
way. In its 2006 annual report, Arriva plc, a transport business (responsible for the
UK’s Crosscountry rail service and a number of bus services), said that its 2006 divi-
dend was ‘five per cent higher than last year, in line with our policy of stable dividend
growth’.
Perhaps surprisingly, Ettridge and Kim (1994) found that where a change in
accounting methods led to higher reported profits, and to a higher actual tax charge,
dividend levels seemed to increase. This seems strange, since the investment oppor-
tunities and the level of operating cash flows were not affected by the accounting
change. Higher tax payments were the only real effects of the change. This implies that
businesses relate dividends more to the reported accounting profits than to the under-
lying economic reality.Share repurchase and MM
Share repurchase is a very common activity in the UK and it seems to be increasing in
popularity. Oswald and Young (2002) looked at UK buy-backs by UK listed businesses
over the period 1995 to 2000. They found that buy-back activity in 2000 was seven
times what it had been in 1995. Casual observation suggests that since 2000 the popu-
larity of share repurchase has increased still further. It is estimated that in the USA
businesses spend out more on share repurchase than on dividends (Grullon and
Michaely 2002).
On the face of it, share repurchase is an example of businesses following the MM
principles and returning to shareholders funds which they are unable to invest pro-
fitably on those shareholders’ behalf.
Some businesses seem to relate their share repurchase to the MM ideas. For exam-
ple, Marks and Spencer plcsaid in its 2007 annual report: ‘The Company engages in
share buy-backs to create value for shareholders, when cash flow permits and there is
not an immediate alternative investment use for the funds.’ MM could almost have
written this themselves!
Some businesses seek to relate share repurchase to capital gearing. The oil business
British Petroleum plc(BP) said in its 2007 annual report: ‘We aim to invest in our opera-
tions; to pursue a progressive dividend policy; to maintain our gearing ratio within
a range of 20 to 30% and to return any surplus cash to shareholders, circumstances
permitting.’ Again, the MM principles are being followed on dividends and share
repurchase, taken together, but with capital gearing being taken into the equation. BT
Group plcsaid in its 2007 annual report: ‘BT seeks to maintain a solid investment
grade credit rating whilst continuing to invest for the future and with an efficient bal-
ance sheet further enhance shareholder value.’
Some businesses seem to relate share repurchase more to enhancing earnings per
share (EPS) than to following the MM ideas. Of course, buying back shares reduces the
level of equity and, presuming no equivalent debt repayment, increases capital gear-
ing. If a business can buy back some shares, without it affecting after-tax profit pro-
portionately, EPS will inevitably increase. In its 2007 annual report, British Airways plc
said of its authority to make share repurchase that ‘The authority will be exercised
only if, in the opinion of the board, this will result in an increase in earnings per share
and would be in the best interests of shareholders generally.’ The high street retailer
Next plcsaid in its 2007 annual report: ‘Earnings per share have risen by 14.7% to
146.1p, enhanced by the beneficial effect of share buybacks over the past two years.’