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June 02, 2005

Why Are Auto Dividends So Low?

Dan Bill Gross is surprised that GM and Ford are paying so much in dividends--a 6.33% dividend yield for GM, and a 4% dividend yield for Ford. I, by contrast, am surprised that they are paying so little. According to Gross, Ford has $23 billion in cash and yet a stockholder's total equity value of only $18 billion. If that is true, why not spend $18 billion on a special cash dividend? They will then have gotten their entire current investment out. And they will still own the company, and have their equity claim on whatever future profits it will make. That would do more for shareholder value than the managers' current strategy is doing. And managers do have a fiduciary duty to pursue shareholder value wherever they find it, right?

Ford's dividends are so low precisely because its managers are not concerned solely with shareholder value, but also with the long-term survival of the company, and do balance off the interests of other stakeholders against the interests of the shareholders who supposedly elect them. And Ford's dividends stay low because the perceived political risks to Wall Streeters who mount a takeover of the company and then pump out its cash are very high.

Here's Dan Bill Gross's column:

The Poisonous Gift - Ford and GM are in big trouble. So, why do they keep paying fat dividends? By Daniel Gross: The stocks of GM and Ford may be slumping. But investors can take solace in the healthy dividends they pay: $2.00 per share annually for GM, representing a 6.33 percent yield; and 40 cents per share annually for Ford, representing a 4 percent yield.

But why do these struggling companies still spend cash on dividends when they could use it for R&D or to meet pension obligations? After all, many analysts believe that if current trends continue, GM may be headed for bankruptcy. Standard & Poor's in early May downgraded GM's debt to junk status. GM has acknowledged that it might not be able to meet the pension and health-care obligations it has made to employees and retirees. Ford, in somewhat better shape, is still clinging to its investment-grade credit rating. There's substantial doubt as to whether GM and Ford can meet the financial commitments to which they are legally obligated, which makes these discretionary dividend payments seem all the more baffling. Dividends are a means of sharing profits with shareholders and of encouraging investors to hold on to stocks--both worthwhile and sensible goals. With the passage of the dividend tax cut in 2003, dividends are an even stronger tool. When companies make money and can easily cover their debt payments and pension obligations, dividends are a no-brainer way to please shareholders.

But the calculus should change when losses pile up and when long-term mismatches between resources and obligations start to take shape. As Ford's most recent quarterly report shows, the company has about $23 billion in cash and $161 billion in debt. In the quarter, it spent nearly $2 billion on interest payments. Ford, which has already reduced profit projections for the year, hopes that its auto unit will scratch out a pre-tax profit in 2005. And yet the company plans to pay out more than $732 million in dividends this year.... In the first quarter of 2005 alone, GM spent nearly $3.7 billion on interest on its $291 billion in debt. Yes, GM has $52 billion in cash and marketable securities, and much of the debt rests on the company's profitable financing arm. But as the quarterly report notes, the company owes more than $37 billion in pension and other post-retirement benefits to employees. Worse, it's hemorrhaging cash. GM's automotive operations lost $1.3 billion in the first quarter of 2005. And yet GM plans to spend $1.13 billion on dividends this year....

At both companies, the dividend payments are tiny compared to revenues, overall debt loads, and outstanding pension and health-care obligations. But if every dollar counts, so does every billion. There may well come a time in the not-too-distant future when $1 billion could mean the difference between bankruptcy and solvency for one of the carmakers. Both companies are facing intense pressure to make the best use of their cash. GM could take the money it spends on dividends and pay down a chunk of the debt on its auto operations or chip away at its mountain of liabilities--things it's required to do by contracts and that would enhance its long-term solvency.

Of course, were they to eliminate the dividend, Ford and GM would give the institutions that hold most of their stock an incentive to flee. And to the extent shareholders automatically reinvest the dividends in GM and Ford stock, it can allow the companies to issue new stock continuously without going to the trouble of making large offerings. Dividends are also a great tool for compensating executives on the sly. Shareholders might look askance at large bonuses and salaries for executives when the company is floundering. But dividends--which are paid to all shareholders--are less likely to raise hackles. According to GM's proxy statement, CEO Rick Wagoner owns about 200,000 shares, making the dividend worth about $400,000 annually to him. (His base salary and cash bonus in 2004 totaled $4.66 million.) At Ford, members of the founding Ford family still own huge slugs of stock, detailed in Ford's proxy statement. The 26.28 million shares owned by William Clay Ford Sr. throw off $10.5 million in cash in dividends annually. Bill Ford, the current CEO, owns nearly 8.7 million shares. So, he can make highly public symbolic belt-tightening statements--like agreeing to give up his salary until the car business starts making money again, as he did last week--without forgoing compensation. Bill Ford will take home about $3.5 million in dividends in 2005, taxed at a rate far lower than his wage income would be.

Ford and GM pay dividends because they are obsessed with the goodwill of shareholders. This solicitous attitude contrasts sharply with the generally antagonistic attitude they take toward their unions. Faced with a slow-growing business and difficulty in making profits, management each quarter has to decide whether it will meet its obligations to capital (dividends and interest payments) or its obligations to labor (pension and health-care benefits). Every quarter, as GM and Ford dole out their dividends while contriving ways to shirk promises made to employees and retirees, capital wins another battle.

Posted by DeLong at June 2, 2005 12:23 PM