Fiscal Cliff

11.28.12

Fiscal Cliff Fears Drive Huge Spike in Dividend Payouts

Taxes on dividends may go up on January 1. And companies are shoveling dividends out to their shareholders before the taxman comes calling.

It’s finally happening. Barack Obama’s redistributive policies that soak the rich are forcing America’s companies to…give money back to their investors? Although the end result of the fiscal cliff negotiation is still uncertain, one thing is clear: tax rates on dividends, which now max out at 15 percent, are certainly not going to down. They may stay the same. But they also are likely to rise—even to double. With American companies engorged on cash and easy access to credit, that means the hottest Christmas gift to the American investor is big special dividend.

In the weeks since the election, Costco, Las Vegas Sands, Dillard’s, Ethan Allan, Brown-Forman (the beverage company behind Jack Daniels), and ADT have all recently announced special dividends. Walmart announced it would move up its regular first quarter dividend to December 27, just in time to dodge the tax-man. So far, according to the market research firm Markit, 103 companies have announced special dividends in the fourth quarter; 66 of them have done so since the election. Markit also projects that at least 20 more companies will declare special dividends before the end of the year.

The dividend-gushing companies operate in a range of industries: retail, gambling, spirits, furniture. But many of them do share something in common: substantial family and insider holdings. That is to say that ownership is disproportionately concentrated in a group of managers, or in a group of family members who exert influence over the company. “In cases where insider holdings are concentrated in the board and executive levels, there exists not only the incentive, but also the capability to declare special dividends,” said Chaitanya Gohil,  Vice President of Markit Dividend Research.

There is probably no better example of this trend than Sheldon Adelson, the chairman and CEO of the casino giant Las Vegas Sands who was a prolific backer of Republican candidates in 2012. Adelson and his wife, who together control more than half the company, will likely earn some $1.2 billion from the company’s special dividend payout of about $2.3 billion.

Members of the Brown family, who control most of Brown-Forman’s voting stock (the CEO, however, is from outside the family), will get around $234 million from the dividend the company is paying. Brown-Forman, according to its most recent quarterly filings with the SEC, has $361.5 million in cash on its balance sheet. The ratings agency Fitch projects that the roughly $850 million payout will be debt-financed, meaning that the company would have to borrow money (likely at rock-bottom interest rates) to get money to its shareholders, a subset of whom own the shares that actually let them control the company. Both Las Vegas Sands and Brown-Forman also announced increases in their regular scheduled dividends going forward.

But it’s not just the insiders who are giving themselves piles of cash as soon as they can. Costco, the retail giant and liberal darling (co-founder Jim Sinegal spoke at the Democratic National Convention) announced Wednesday that it will be giving back around $3 billion to its shareholders in a special $7 a share dividend. In a statement announcing the payout, Costco Chief Financial Officer Richard Galanti said the dividend was part of “our latest effort in returning capital to our shareholders” and that the retailer’s “strong balance sheet and favorable access to the credit markets allow us to provide shareholders with this dividend.” The company didn’t mention the prospect of tax rates rising, but it did make sure to note that the dividend is “to be paid before the end of the calendar year.”

The rash of dividend payouts is a great case study of the way public policy can affect corporate decision-making. One of the explicit goals of the Federal Reserve’s quantitative easing policy was to bring down interest rates on corporate bonds and thus enable more corporate borrowing and investment. These low rates and possibility of a large jump in dividend taxes make a large, one-time dividend irresistible to companies who want to do right by their shareholders. Thanks to the Fed, money is close to free for profitable companies. Thanks to the fiscal cliff, companies have a huge incentive to pay out big dividends now. The low-interest rates it has engineered may not exactly be leading to as much, say, hiring and factory building as the Fed would like. But the dividends to large shareholders will provide ready stimulus to the asset management, vacation home, and boat industries.

“Dividends to large shareholders will provide ready stimulus to the asset management, vacation home, and boat industries.”

We’ve seen this story before. In 2010, when the Bush-era tax rates on dividends were initially expected to expire, companies covered by Markit issued 117 special dividends; 74 of those were issued in the fourth quarter and 58 were issued in November and December alone. Just like now, there was a high level of uncertainty over the future of the Bush tax cuts. Of course, the dividend payers in 2010 misread the situation in Washington. The low rates on dividends were extended for another two years.

Michelle Hanlon of MIT and Jeffrey L. Hoopes of the University of Michigan found a similar trend in a paper they co-authored this year. They noted “a statistically and economically significant surge in the number of special dividends near the end of 2010,” furthermore, the spike was “concentrated in companies with relatively high ownership by insiders.”


Research done well before the planned expiration of the Bush tax cuts finds a similar relationship. Francisco Pérez-González, a finance professor at Stanford’s Graduate School of Business, wrote in his 2003 dissertation (PDF) that “dividends respond to the tax preferences of large shareholders.” As the difference between taxation on dividends and capital gains decreases, companies that have an individual as the largest shareholder are more likely to pay out dividends.

Pérez-González found that while firms with large insider holdings generally pay out less in dividends, “firms with individual large shareholders increased dividend payouts in the late 1980s and reduced them after 1993,” in accordance with the individual tax treatment of dividend payouts. Between 1988 and 1992, the top marginal income rate (which applied to dividends) was either 28 and 31 percent while the top capital gains rate was 28 percent. During those years, dividend payouts for companies where the largest shareholder was an individual increased 12 percent, while there was “no evidence of such an increase for firms with nonindividual large shareholders.” Subsequent research found precisely this effect after the Bush tax cuts (PDF), which brought dividend and capital gains rate more in line with each other. In an email, Pérez-González said that what we are seeing now is “precisely the same effect: [insider shareholders] have the incentives and the power to influence payout policies.”

Markit describes insider holdings as “the key variable in projecting special dividends in this unique tax environment” and notes that the average insider holdings in companies that declared a special dividend in the fourth quarter of 2010 were 30 percent. According to Markit the average insider stock ownership of companies that have declared a special dividend since the election is 27 percent.