Around this time in a recession, a related dilemma - the desire to maintain corporate appearances versus the imperative to address business realities - becomes an issue for companies, especially concerning their dividend payments. Take two companies that reported first-half profits last week - engineer Spirax-Sarco and wholesale distributor to cargo-handling group John Menzies. Both companies reported reduced profits, though in neither case was the surplus all but wiped out. At the pre-tax level, Spirax's profits were 28 per cent down and Menzies' were 35 per cent lower. So, we might think, both companies had the means to pay a dividend. Yet, in the event, only Spirax did. It raised its interim payout by 5 per cent, while Menzies axed its interim.
Arguably, however, the interesting feature was how each company reported its decision. Spirax was happy to tell us that the increase "demonstrates the confidence of the board in the strength of the underlying business and the group's prospects", and much else besides a warm, fluffy nature. Meanwhile, Menzies was terse. "With the group's continued focus on debt reduction, the board is not recommending an interim dividend", was all it said. So the bosses of both companies put the stress on appearance: at Spirax, trumpeting the fact that the payout has been increased - as it has been for the past 41 years; at Menzies, drawing as little attention as possible to the inconvenient truth.
Conventional financial theory says that such contrived responses are neither here nor there because dividends don't matter. The theory says it makes no difference to a shareholder's wealth whether a company pays dividends or not. Superficially - and ignoring the effects of taxation - that's true. Clearly, if a company pays a dividend, then its net assets have been reduced by the amount of the payout, and that fact will be reflected in its share price. So a shareholder will be neither better nor worse off whether or not he receives a dividend. Similarly, if the shareholder wants some income from his investment, he can almost as easily sell a few shares as pocket a dividend. The effect will be the same.
On that basis, it is of no consequence that Spirax has a 40-year dividend record to maintain, nor is it significant that Menzies has axed its payout. It is irrelevant to their shareholders whether each company pays a dividend or not.
Dream on. Like so much of orthodox financial theory, which has its roots in classical economics, this bit is fine at dealing with logic, but lousy at dealing with people. Yet shareholders are people - even in institutional investors there are people somewhere - and people come with their own peculiar logic. And in that odd world, dividends matter.
First, they matter to private investors from a point of view of self control. Investors can sensibly treat their dividends as income to be spent. But, if they have to create their own income by selling shares, the danger is that they will behave recklessly.
More contentiously, investors use dividends to help 'segregate' their feelings about their investments. So if, say, a company's share price is rising and it is increasing its dividend, then segregation means that shareholders get a double high - one buzz from rising wealth; another from rising income. However, if, as in the case of Spirax, the share price has been falling - at 978p, its price is 18 per cent off its 2008 high - then segregation means that dividends act as a consolation. A shareholder will say to himself: "Alright, the fall in the share price has hit my wealth but, never mind, the dividend compensates a little."
Even in a case such as Menzies', something like segregation applies. The point is that investors get more upset by losses than they are made happy by profits. That being so, the worst thing a company can do is dribble out bad news by, for example, repeatedly cutting a dividend. For shareholders, each dividend cut is as nasty to stomach as the previous one. The best course is for the company's bosses to take a deep breath - as Menzies' did - and axe the payout in one go. Then, hopefully, the pain is over and done with.
So Spirax's and Menzies' bosses have done the right thing. But only up to a point. True, the latest financial theory says that appearances, after all, do matter. But it does not say - and cannot say - that appearances are rational. So, for example, Spirax's bosses can't really argue that their company's formidable dividend record has enhanced their shareholders' wealth. It follows that they should not get obsessed about maintaining it. Indeed, in the wider scheme of things, company bosses should not get hung up with appearances at the expense of reality any more than shareholders should. That both parties seem to do so is not to their credit. However, that is not a reason for bosses to favour appearances over reality, nor an excuse for failing to treat their shareholders intelligently.
