Hollowed out firms make risky distributions to shareholders
Richard Murphy interrogates the increasingly common practice of hollowed out firms, where entities have over-distributed profits which leaves weak and vulnerable balance sheets supported by loan financiers who often have too much to lose by pulling the plug.
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"This suggests that we now have a financialized corporate world where financial engineering and creative accounting play an enlarged role" ... surely hardly the surprise that author claims.
Financial engineering is antithetical to the foundations of basic accounting principles, so wouldn't be used except where a degree of subversion is intended. And once started, why not push the boundaries a little more? This is just another aspect of short-termism and unbalanced rewards - I could go on.
A fascinating read. An interesting follow up would be a study of the companies that were not in the FTSE 350 for the whole period (at least 168 and presumably a fair bit more). How many fell out because they were adopting the same policies as the top quintile?
It would be interesting to see analysis against other factors, eg where in their life cycle are these companies, and what is the distribution of industries across the quintiles. There is no comment on whether the quintile 1 companies with greater gearing & payouts are in fact able to access these higher levels of debt because they have lower inherent business risk and are therefore deemed able to bear greater financial risk by lenders. Or are the quintile 4 and 5 companies ones earlier in their life cycle, in growth markets and therefore more easily able to grow revenue, but therefore inherently more risky and therefore unable to gear to such an extent. Or are they ones in fixed asset intensive businesses and accordingly need more capex.
Without a full consideration and disclosure of context and causality I wonder how firm the conclusions are.
Extract above
'We examined the investment and productivity performance of large UK listed firms who make outsized, and potentially financially risky, distributions to their shareholders.'
When I read the heading 'Hollowed out firms make risky distributions to shareholders' I thought the article related to crappy little company's on AIM, I had no idea it related to large Uk listed Companies.
A good thorough article by Richard.
Please tell me my crappy Bank shares are going to go through the roof in 2022 :).
IMHO the more important thing re listed companies and risk to their dividends is cashflow rather than earnings. You mention companies with high levels of balance sheet goodwill distributing greater earnings proportions, but of course if said earnings are after amortisation their ability to shed cash may be far higher than their reported earnings. (Think say mature tobacco companies)
Now of course there is risk, these are old beasts with limited future growth, but frankly I suspect I would generally feel safer with an uncovered dividend from a cashflow positive beast than a lower dividend from an over investing younger entity (remember markets often punish companies if they carry too much cash and if they do not distribute directors have been known to buy baubles they never should have touched)
To me surely the warning is more a dividend being paid combined with increased borrowings rather than necessarily being in excess of reported earnings.(though it may be an indicator)
I used to invest following a HYP approach though as I have got older I have tended more to ITs instead, high yield always stuck me as chasing the incorrect indicators but of course calculating cashflow per share can be tricky, especially re capex adjustments.
(I have poor regard for the reporting of profit so all this may just be my latent prejudice)
Without a full consideration and disclosure of context and causality I wonder how firm the conclusions are.