Why would companies borrow to pay dividends now?

Posted Oct 6th 2009 12:00PM by Zac Bissonnette
Filed under: Management, Competitive Strategy

The Wall Street Journal reports (subscription required) on a disturbing trend taking place in board rooms across America: Public companies are borrowing money to pay dividends to shareholders.

Companies say that they're doing it to take advantage of low interest rates, but here's what's so dumb about that: The low-interest rate environment makes dividends less valuable too because the cash can't be invested at a high rate of return. Worse, these companies are needlessly amplifying risk: The bankruptcy courts are littered with the corpses of companies that paid dividends instead of paying down debt, and the result was that shareholders, workers, and creditors were wiped out completely in the name of a short-term increase in yields.

Need another reason that bond offerings to support dividends are a bad idea? There are tremendous frictional costs. The act of selling bonds to pay cash to shareholders costs millions in investment banking and administrative investments -- and the paper-shuffling act distracts management from finding ways to actually create value.

Borrowing money to pay dividends to shareholders is a high-risk proposition without any meaningful upside -- kind of like jumping in front of a steam roller to pick up a penny (or a Lehman Bros. stock certificate -- or Enron, or Circuit City, or any of the other infinite number of companies that plunged into bankruptcy after taking on excessive debt to buy back stock or pay dividends).

Tags: Dividends, inthenews