Citigroup, after stubbornly insisting on paying out dividends, has realized how paradoxical that practice was. As noted elsewhere on this blog, dividends are a way to return excess capital to shareholders. Yet, Citigroup keeps raising capital - implying they have too little capital. Perhaps the Citi board thought that the dividend was necessary to hold up the share price, which is critical to issuing new equity.
So what explains cutting the dividend now? Has management just now realized that issuing dividends while raising capital both destroys value (round-tripping capital just generates fees and administrative costs) and confuses the market? Or is this a sign that Citi no longer believes it can rise capital from private sources, so why bother worrying whether cutting the dividend causes share prices to fall?
Monday, November 24, 2008
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4 comments:
"As noted elsewhere on this blog, dividends are a way to return excess capital to shareholders."
Yes, but it also has an effect on investors. I might be someone who only buys stocks that pay dividends. I'm, therefore, the kind of investor who buys and holds. So, one can give a rationale for paying dividends,say, trying to keep the stock's price up,and attract people who tend to purchase more stock over time, that doesn't simply involve excess capital.
Or am I wrong?
Don the libertarian Democrat
I would have to agree....I always look at dividends as the waiving carrot...the prize for purchase. But one has to ask why would a company still offer a dividend when there are no real gains? There are several scenarios...most not that good.
Don, that is true, dividends likely do keep the stock price up - and if the company was raising new common equity in the capital markets, I would be fully supportive of keeping the dividend, since, as you point out, a higher stock price makes it cheaper for Citi to raise capital. However, the fact that the government is providing capital indicates Citi cannot raise private capital. If they cannot raise private capital, they certainly should not be taking in government money and then pushing it right back out the door to private shareholders at the same time. Yes, the stock price is likely to suffer, but that merely comes at the expense of the existing holders, who apparently made a bad investment.
Someday in the (hopefully not distant) future, when Citi is actually earning income again, I think they should do a large common stock offering to replace all government provided capital. Concurrent with that offering, they could reinstate dividends.
Kyle, Thanks for the answer. What made me consider the question was the extent to which the decline in the price of Citi's stock contributed to their crisis. You make a good point.
Take care,
Don
the libertarian Democrat
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