Last year, the companies in the Standard & Poor's 500-stock index reduced their dividends by $48 billion. Today, payouts are running at an annual rate of $206 billion. So far, dividends are down 9.4% from 2009's first quarter.And, now for the incentives
If you took away only the top 25 dividend-paying companies, half the total income of the index would disappear. A decade ago, half the dividend dollars came from 35 companies. The biggest firms make up considerably less of the total value of the market than they did 10 years ago—but a lot more of the total dividend income.
That matters because, while many people buy stocks in hopes of scoring profits down the road, dividends deliver cash right now. And if the vast majority of the cash comes from a tiny minority of companies, small changes can have big effects.
In a sense, that has happened already. The credit crisis of the past two years choked off the dividend stream that financial companies had long generated. Companies that went bust, took taxpayer bailouts or lost billions of dollars no longer had a pool of profits from which they could shell out dividends to their investors. In 2007, 14 cents out of every dollar in dividends paid by the S&P 500 came from only five financial stocks. At current rates, the five biggest financials are providing only 2% of the dividend dollars.
But many other companies are declining to pay dividends not because they are unable but because they are unwilling. U.S. nonfinancial companies have amassed nearly $1 trillion in liquid assets. While much of that is in marketable securities, senior index analyst Howard Silverblatt of S&P estimates that more than $580 billion is pure cash, which could effortlessly be paid out in dividends.
Firms may sit on cash for good reasons—as a precaution against a further slump in the economy, as a war chest for acquiring competitors at cheap prices or as a funding source for building new factories or developing innovative products.
But the recent turnaround in the credit markets is giving firms the ability to raise capital freely again. Excess cash can goad chief executives into making impulsive acquisitions at high prices, splurging on palatial headquarters or overfunding underwhelming projects. In fact, academic research shows that companies with the highest levels of cash go on to become less profitable in the long term; one recent study found that high-cash firms earn future profit margins 1.5 percentage points lower than those that carry the least cash.
No wonder the late CEO of Pennzoil, Hugh Liedtke, used to joke that he believed in "the bladder theory" of dividends: Companies should pay out cash so the managers wouldn't drain all the money away. (Mr. Liedtke used a cruder synonym for "drain.")
There is a less savory reason companies let cash pile up instead of paying it out. Dividends dampen volatility, and when stocks bounce around less, options on those shares are less valuable. A CEO who pays or raises a dividend indirectly reduces the value of his stock options. The money that goes into your pocket today cuts the amount of money that will go into his pocket tomorrow.