Friday, December 20, 2013

In Defense Of Dividends

Matthew Yglesias has an incoherent attack against dividends, which he declares "evil" (!).

One way in which it is incoherent is that on the one hand he argues that they are supposedly worse for shareholders because they are taxed (as if capital gains aren't and as if any discrepancies don't reflect flaws in tax laws as opposed to the principle of dividends) , but on the other hand argues that it is bad if shareholders benefit because shareholders are disproportionately very rich, belonging to the infamous top 1%.

Similarly, he on the hand argues that stock repurchases are the best way to beenfit shareholders and on the hand arguing that it is bad if shareholders benefit.

Aside from being incoherent he also fails to understand basic economic in several ways. He argues that dividends are somehow not just because most current shareholders in for example General Electric didn't themselves provide funds for the company's investment. True, but irrelevant, as the investors who did finance these investments got their reward by being able to sell these shares to current owners (and through dividends). And it was the prospect of current and future dividends that was directly or indirectly the basis for these purchases from the investors that created for example GE.

Similarly, when pleading for stock repurchases as a better alternative to dividends he again reveals his economic ignorance as he says that they will increase the value of the stock. Now, it is true that as a complement to dividends, they will increase the value of stocks. But if it is a permanent substitute, and that must be what he has in mind by declaring them evil and wanting them abolished, it will make shares basically worthless, except for perhaps the rare number of people with enough shares to gain actual power over a company.

The reason for that is that the source of a stock's value, setting aside voting rights, is entirely the present value oif future cash flow that goes to the holder of stocks, which is to say the present value of future dividends.If you permanently eliminate, as opposed to doing so temporarily because the company is in a hopefully temporary crisis or need the cash for investments, then stocks will have no objective value at all. Making them more scarce through repurchases won't make it more valuable as long as it remains objectively without value.


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