Holman Jenkins has a most peculiar column today which seemingly tries to defend Citigroup’s decision to continue paying dividends, even as it’s raising billions of dollars of capital elsewhere. Except he never quite comes out and says that Citi is doing the right thing: the best that he can come up with is that it’s possible that Citi is doing the right thing. And even getting there is something of a stretch.
Holman has two main premises. Both are true, as far as they go, but neither does a particularly good job of getting him to where he wants to go.
1) Money is money. Whether banks are wiser to replenish their depleted capital by retaining income now used to pay dividends, or wiser to raise the capital from outside and keep paying the dividend, depends on which is a cheaper source of capital.
2) Money is money. Whether a company retains its earnings or pays them out, shareholders are still the beneficiaries of its cash, and shareholders are not so dumb they can’t figure this out. They are not so dumb, in other words, as to prefer receiving a dividend if it would be more advantageous for their company to deploy its cash elsewhere.
If I were starting from these two premises, it wouldn’t take me very long to come to the conclusion that continuing to pay out dividends was not a very clever idea. From the first, I could compare the largely metaphysical costs of simply retaining earnings, on the one hand, against the very real and very large costs of borrowing capital from major institutional investors, on the other. Unless those metaphysical costs of cutting the dividend were obviously huge – and they’re not – then it would seem to be the cheaper, and therefore better, option.
From the second premise, I would deduce that shareholders will have voted on the present strategy every minute of the trading day. I would look at the results of that vote – shares trading at less than half their level this time last year – and conclude that they’re not very happy with the dilution strategy at all.
So how does Jenkins decide otherwise? He first makes an irrelevant point:
Remember, Abu Dhabi, Singapore, Kuwait and various muckety-mucks just put more than $44 billion into Citi on terms that lock them in, while normal shareholders can come and go as they please.
Shareholders come and go by selling stock to each other, not by withdrawing any capital from Citigroup. If Citi decided to retain earnings rather than borrow money from muckety-mucks, then those retained earnings would be just as "locked in" as anything from other sources.
Jenkins follows this up by an argument which betrays his WSJ editorial page roots:
For years, Citi’s shareholders have been concerned about a porky cost structure compared to its peers. A dividend is a form of discipline, imposing on management a need to be careful about costs so as not to be seen cannibalizing the company’s long-term value to pay the dividend.
This is known in political economy circles as the "starve the beast" argument. It’s used to justify tax cuts, on the grounds that if the government gets less revenue, it’ll be forced to get more serious about cutting spending. So far, it’s never worked.
And so we get to the point at which Jenkins ties everything up:
The company (so far) has had no trouble raising new capital – its offerings have even been oversubscribed – but another dividend cut might damage this appeal. It might instead be seen as management throwing in the towel on rationalizing Citi’s costs and simply using Citi’s cash flow to entrench itself. In which case, cutting the dividend could prove a very costly means of raising capital indeed.
I’m a little bit unclear as to what the word "itself" in this passage is referring to. Is it referring to Citigroup, the entity? If so, then Citigroup entrenching itself by means of its own cash flow would seem to be a jolly good idea to me, isn’t that what businesses are meant to do?
On the other hand, if the "itself" refers rather to Citigroup’s management entrenching itself using Citigroup’s cashflow, then the clear implication here is that shareholders are unhappy with the present management. They might be unhappy because they don’t like the current dividend policy – a possibility which seems not to have occurred to Jenkins. Or they might be unhappy because they think that the present crew, led by Vikram Pandit, just isn’t very able when it comes to managing a company of 374,000 employees. Either way, cutting the dividend is unlikely to make the shareholders even more ill-disposed towards management than they already are.
I think that Jenkins’s argument, insofar as there is one, boils down to "if Citi cut the dividend, then the share price might fall". Which would be a much more powerful argument if it weren’t for the fact that the share price has been falling quite steadily anyway. Just maybe, if Citi cut the dividend, then the share price might rise. Stranger things have happened.
(HT: Abnormal Returns)