Monday, May 23, 2016

The Need for a Dividend Disclosure Policy

[The following guest post is contributed by Soham Roy & Akhil Nene, who are 5th year students at the National Law University Odisha]

In a recent Board meeting, SEBI provided an in-principle nod to mandating the top 500 listed companies in India (according to market capitalization) to disclose a dividend disclosure policy. Such a policy may include circumstances under which their shareholders can or cannot expect dividend, financial parameters that will be considered while declaring dividends, internal and external factors that would be considered for declaration of dividend, policy as to how the retained earnings will be utilized, and provisions with regard to various classes of shares.

Lately, this issue has gained a lot of importance because of excessive payments of dividends just before an initial public offering (IPO) of shares. In 2015, as Inter Globe Enterprises was readying for an IPO, it trebled the value of its dividend in 2015 over what it paid in the previous year. Inter Globe Enterprises increased its dividend expenses per share from Rs. 12,299 for year ended 2014 to Rs. 35,169 for the year ended 2015. This decision was taken by Inter Globe Enterprises eleven days before it filed its Draft Red Herring Policy (DHRP) with SEBI.

The larger question here is the importance of dividend payment for investors. Very simply put, there are essentially two ways in which investors obtain returns: dividend and capital gain. The declaration and payment of dividend is one of the most important decisions for a company as the company has to strike a balance between the percentage of earnings it should utilize to finance its operations and the percentage it should use to distribute dividends to shareholders. This decision has ramifications on the business as the payment of large dividends reduces the ability of the company to fund large projects and often under such circumstances the company will be forced to access the capital markets to fund such projects.

Under Indian company law, there is complete discretion in the hands of the board of directors as to whether dividend is to be paid or not, and also as to the amount of dividend to be paid.  Research on dividend policy has also shown that dividend policy per se will have an impact on the price of a company’s stock price independent of earnings.[1] Therefore, announcement of a dividend policy can only be helpful for investors to make investment decisions. Spelling out a clear dividend policy will help investors make a more informed choice. 

However, the proposal to extend it to only top 500 listed companies by market capitalization is not welcome. Mandatory disclosure of dividend policy should also be extended to companies who are in the process of making an IPO. Another concern is that companies might circumvent this policy of mandatory disclosure by using broadly drafted statements, which will leave a lot of discretion in the hands of the Board. 

In November 2015, the Financial Reporting Council’s (hereinafter FRC) Financial Reporting Lab had come out with the report titled “Lab project report: Disclosure of dividends – policy and practice” which relates to the dividend disclosure policies and how it can be made more relevant for the investors. This was undertaken because many of the FTSE 350 companies in their annual reports failed to provide information relating to distributable profits. As Stated in the Lab project report: “Only 23 FTSE Companies disclosed the distributable profits balance (of the parent company) in their 2014 annual report and accounts (annual report)”. This report was made with the contributions from 19 companies and 31 investors. The aim of this report is to investigate into the issues and to look at the best practice.

The report states the methods by which the dividend disclosures can be improved by the companies. The main aim of the report is to facilitate the listed companies to provide relevant information to the investors. The FRC in its report has also identified the issues that relate to determining the profits levels and the profits that the company can legally distribute and also that the kind of disclosure that is made would be dependent on the level of resources a company has compared to its proposed dividends.

It was stated by the investors that they wanted the companies to disclose the circumstances under which the companies would pay special dividends or buy back shares and to show the step taken by them is in the interest of the shareholders.

All investors consider that the disclosure of dividend resources, i.e. cash and the amount of the company’s reserves legally available for distribution under company law (distributable profits), is helpful in circumstances where the ability of the company to pay dividends is, or might be, insufficient relative to the level of dividends indicated by the policy. Some investors believe that distributable profits are always required to be disclosed. The FRC understands that as per the Companies Act 2006 the companies are not required to separately identify the distributable profits on their balance sheet.

We can conclude that the report tries to facilitate the investor’s issues in following ways:

1.         The report provides all the listed companies with some guidance on disclosure of dividends and distributable profits; it is applicable to all the listed companies and does not depend upon their size.

2.         In the report it is noted that when the companies disclose information relating to dividends they usually do so by spreading over the financial statements, shareholder information sections and the strategic report. To avoid that, the companies must link the dividend disclosures to important information which is included in the annual report and also include the risk disclosures as was requested by the investors; this would go on to make the annual report much more concise and clear and would also help avoiding the repeating of information and that would also increase coherence.

SEBI should use this report and prescribe certain guidelines to ensure that companies do not try to circumvent the policy by using broadly drafted policy and generic disclosures. The purpose of this disclosure is not to coerce companies to make dividend payments, but it is to ensure that investors make more informed choices.

- Soham Roy & Akhil Nene

[1] Law and Economics of Dividend Policy-Daniel R. Fischel, Virginia Law Review, Vol. 67, Issue 4 (May 1981), pp. 699

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