What incentive do the directors of a corporation have to pay dividends to the stockholders? Why do they care what the secondary-market value of the corporation’s stock is?
In some cases, stockholders will vote out managers who don’t satisfy them. But often, it is the corporate management themselves that are the majority shareholders (they own 50%+1 of the shares). So why shouldn’t they just take all the corporation’s profits for themselves and never pay any dividends? After all, once the initial public offering has been done, the value of the stock doesn’t matter anymore, right?
Because if the value is small, there’s going to be corporate takeover, and he will likely end up on the streets.
That wouldn’t make any sense.
If he owns most of the shares, then a part of his personal wealth is determined by their value. By acting in a way that would make the stock value drop, he’d be basically peeing on his own leg.
The drop in the value of the stock would be more than compensated for by the increased income of the directors. If a corporation earns $1 million a year, and the CEO owns 50% of the shares, then paying a dividend would yield $500,000 for the CEO; however, if the CEO instead decided to keep all the money as a bonus, then the stock price will drop to zero, but the CEO doesn’t care because the CEO gets even more money that way.
(I know I must be missing something, since obviously stocks do exist and have nonzero values.)
Over the course of many years perhaps that would be possible, but during any single year that would ridiculous.
The value of the stocks is also determined by the assets the company has, and which can be sold if the owners so desire. Profits in any given year are a small fraction of the total value of assets. However if the CEO owns most of the stock, and he won’t sell it, and he won’t pay any dividends, then the stock is useless (maybe except for speculative purposes), and it’s value will be next to zero. This means huge losses for the stockholder-CEO that he will not be able to compensate for decades to come, no matter how big the bonuses are.
Also, if the time comes that he decides the company needs additional capital, he will not be able to raise it through the stockmarket. No one will show up at the IPO if this is the way he treats his fellow stockholdes.
Profitable companies use most of the profits to expand or improve business. The company can only do these things with the profits left over: 1. Give profits to owners, or 2. Keep them in a bank account. 3. Pay off debt.
Option 1: There are two ways to do this: Give owners cash in a dividend or buy back ownership. Most companies use one of these options. There are tax reasons on the side of the owner that may make receiving dividends vs increased stock price more or less attractive.
Option 2 is used normally for small profits beyond those reinvested. Otherwise another company could purchase the stock of the company and then use the excess stored profts to purchase the rest of the company. Besides the owners can also keep their cash in a bank account anyway and don’t need the company to do it.
Option 3 is used when the owners believe that they have too much debt and worry about bankruptcy. Otherwise the owners like debt as they can deduct interest payments and as long as they can service the debt they own the earnings.
There is also an element of confidence that dividends provide that share buy backs don’t. That is the owners get cash in the same manner as an interest payment.
One is that it’s an artifact of regulation. I don’t think corporations can legally have huge amounts of cash or bonds or whatever so if they can’t spend it they have to pass it on to shareholders.
Another is that there’s an agent principal problem - shareholders require that they be given gains now so some incompetant or greedy manager in the future doesn’t squander it.
But yeah I think it’s illegal to take all of the profits if you only own 51% of the shares, since you’re enriching yourself at the expense of other shareholders, when they all have a claim to the wealth of the company in proportion to their ownership stake.