As with previous posts, the chosen subject for this post will revolve around shareholder wealth. The main purpose of a dividend is to; rewards shareholders as a type of compensation for the capital they have invested into a corporation. However, these dividends are not only used as a reward, but also as tool used to analyse the performance of the company by current and potential investors. Ahonory and Swary (1980) discuss the ways in which managers use dividends and earnings in order to release information regarding the performance of their company. An obvious statement would be that the higher the dividend payment, the better the company are performing. This could well be the case; however, there is a wide range of differentiating factors that could also affect the amount of capital used to pay dividends.
Mothercare have recently announced that they will be halting dividends in order to “fund revival” (Financial Times, 2012). Mothercare have made this decision in order to fund the restructuring of their company and finances, with hopes to make it a more profitable corporation. Mothercare’s sales in the UK have fallen in comparison to last year’s figures, and this initially negatively affect share price. This presents an efficient market, with a drop in profitability, a drop in company value. Nevertheless, the announcement that dividends will be halted for the following 3 years sparked a 3.5 per cent increase in Mothercare’s share price. How is this so? The company aim to retain all profits in order to reinvest to make the company more efficient and profitable within the UK. Mothercare’s shareholders have seen the potential in the new strategy and furthermore believe that by maintaining an investment in Mothercare, their investments will yield rewards; be that a higher share price or substantial dividends, or both.
The initial announcement from Mothercare ignited a sharp decline in share price, displaying the Clientele Effect. With some investors only investing into certain companies that meet their specific financial needs. The shareholders that sold shares when finding out the news that dividends were being withdrawn for the following years, realised that this change in strategy did not assist them meeting their specific criteria, and sold their stocks and most probably re-invested.
Mothercare are clearly interested in increasing shareholder wealth, as they are restructuring the company in order to become more efficient and profitable. However this has taken a more long term view and sacrifices have to be made in the short term.
In conclusions, dividends are important to some investors and meaning less to others. Certain investors want an investment that provides an additional income, whereas the opposite type of investor is more occupied with the growth of the share price.
