Is it Rational for a Firm to Borrow Money in Order to Pay Dividends?

Microsoft made the news in 2010 when it borrowed money to pay dividends to its shareholders. Some people may question why a company would borrow money to pay dividends, rationalizing that if a company cannot afford to pay dividends, it shouldn’t borrow to do so. Yet for some companies this decision makes sense.

Dividend Paying Stocks

Many companies pay dividends to their stockholders regularly throughout the year. These are called income stocks because the dividends provide income to the stockholders. Investors purchase stock in these companies in order to receive a regular income. The stockholders expect and rely on the income provided from these dividend payments to increase their investment with the company or to pay their bills. Companies that do not pay dividends are called growth stocks.

Dividend Payment Policy

Company boards of directors set the dividend policy for the coming year and generally maintain the same dividend policy every year. Boards of directors may choose to pay dividends quarterly, semiannually or annually. Boards of directors usually pay the same amount in dividends each time or increase the amount slightly. Companies that pay dividends to their shareholders normally continue paying dividends. Companies that do not pay dividends generally do not start paying them.

Message To Investors

Dividend policies communicate a message to the investors of the company. Companies that pay dividends regularly communicate that the company is stable, growing steadily and rewarding its investors for their commitment to the company. Changes in dividend policies also communicate a message to the investors. When a company with a history of paying dividends chooses not to, the investors perceive this as potential financial difficulties within the organization. When a company with a history of not paying dividends suddenly pays them to its stockholders, the investors perceive this action as an indication of unexpected growth in the company.

Borrowing Money

Sometimes dividend paying companies endure a temporary financial struggle. The company may lack the cash to pay out a dividend one year. The board of directors discusses the message that not paying a dividend will send to the investors. In order to counteract that message, the company may borrow money to pay dividends.

References

• Seeking Alpha: Microsoft’s Strategy -- Borrow Cheap Money, Raise Dividend
• Chest Of Books: Paying Dividends With Borrowed Cash
• U.S. Securities and Exchange Commission. “Ex-Dividend Dates: When Are You Entitled to Stock and Cash Dividends.” Accessed August 13, 2020.
• Unilever. “Dividend history.” Accessed August 13, 2020.
• Walmart. “Walmart Raises Annual Dividend to $2.16 per Share, Marking 47th Consecutive Year of Dividend Increases.” Accessed August 13, 2020.
• Microsoft. “Microsoft Outlines Quarterly Dividend, Four-Year Stock Buyback Plan, And Special Dividend to Shareholders.” Accessed August 13, 2020.
• Energy Infrastructure Council. “AN INTRODUCTION: MASTER LIMITED PARTNERSHIPS,” Page 7. Accessed August 13, 2020.
• U.S. Securities and Exchange Commission. “Real Estate Investment Trusts (REITs),” Page 1. Accessed August 13, 2020.
• Tax Foundation. “Dividend Tax Rates in Europe.” Accessed August 14, 2020.
• Yahoo Finance. “General Electric Company (GE).” Accessed August 13, 2020.
• GE. “GE Plans to Reduce Quarterly Dividend in Conjunction with Revised Capital Allocation Framework.” Accessed August 13, 2020.
• The Nobel Prize. “THIS YEAR’S ECONOMICS PRIZE AWARDED FOR PIONEERING STUDIES OF SAVING AND OF FINANCIAL MARKETS.” Accessed August 13, 2020.
• Deliotte. “International Tax - Hong Kong Highlights 2019,” Page 1. Accessed August 14, 2020.

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