More than a quarter of the UK’s biggest listed companies and a third of large US public businesses spent more on dividends and buybacks in 2019 than they generated in net income, a move that has left many groups at greater risk of collapse.
“Pre-pandemic excesses”, where management focused on maximising short-term shareholder payouts, have “hollowed out” company reserves, according to a study from the University of Sheffield, Queen Mary University of London and Copenhagen Business School. This has left many businesses struggling to cope with the fallout of the coronavirus pandemic.
The report found that 28 per cent of FTSE 100 companies, 37 per cent of S&P 500 firms and 29 per cent of the S&P Europe 350 paid out more in shareholder distributions than they generated in net income in the last available accounting year.
Professor Adam Leaver from Sheffield University Management School said that while the pandemic at first glance looked like an “exogenous shock”, the research showed that “management decisions over the past decade have made companies vulnerable”.
“Their focus on short-term payouts is going to make the recession even deeper, costs to governments much larger and will extend the need for central bank intervention,” he said.
Companies have slashed dividends in recent months as they grappled with the effects of the economic shutdown. Fund manager Janus Henderson has estimated that up to $500bn of cuts to dividends could take place this year globally, depriving pension funds and private investors of valuable income streams.
The study, however, found that many companies had made large shareholder distributions without sufficient cash reserves in place to do so. On average, S&P 500 companies spent 87 per cent of their net income on dividends and buybacks between 2009 and September 2019, while Euro Stoxx 600 groups paid out 72 per cent of net profits between 2010 and 2018.
In order to make those payouts, companies focused on boosting so-called distributable reserves, according to the study. In some cases, companies brought forward income and pushed back costs and contingencies to boost their distribution pot.
The research also found that businesses took on low-grade debt — risking refinancing and liquidity problems in the current climate if the debt is downgraded. There had also been a build-up of intangible assets on company balance sheets, which were vulnerable to writedowns that could push businesses into negative shareholder equity.
“The seriousness of the coronavirus effect should not be downplayed, but the bailouts are needed partly because firms were run in ways that exposed them to procyclical risks in downturns,” the researchers said.
Prof Leaver said that just as companies begin to book operating losses because of the pandemic, some will also be forced to “book a second set of losses through an impairment on fair valued assets”.
“They are going to be doing this when they are already quite levered and their credit rating is going to be hurt,” he warned.
He added: “This is going to happen right across the economy. If you borrowed heavily to buy back your shares and thinned out your equity base, you are not going to have the cushions there.”
Prof Leaver said executive pay plans had incentivised management to make big shareholder distributions. Executives often receive large amounts of their pay packages in shares, increasing the risk that management “lever up [and] buy back shares, which drives up the value of their options, which they can then exercise”.
While this might boost investors’ returns in the short term, over the long term this was bad news for shareholders, as companies were left in a much more precarious position, the research said. Big investors had raised concerns about excessive payouts as far back as 2017.
Sarah Wilson, chief executive of Minerva, the shareholder adviser, said: “At a time when innovation and [research and development] is so important it would seem that financial engineering is taking a higher priority.”
The researchers called for an overhaul of company law and accounting rules, putting more focus on ensuring management prioritised protecting the capital base and that asset valuations were based on actual transactions “rather than subjective estimations of future cash flows”.
Get alerts on Fund management when a new story is published