Distributing dividends from paper profits more than triples the probability of a company making a debt arrangement, a study by the Bank of Israel Research Department finds. The study supports the assumption that controlling shareholders who milk companies for dividends are actually damaging the companies.
The Bank of Israel study examined a specific type of dividend - those distributed from accounting profits. Such dividends were formerly not allowed, but became possible following the adoption of the international financial reporting standard (IFRS). The Companies Law does not distinguish between different types of dividends; it permits distribution of dividends from accounting profits.
The researchers state, "As it is impossible to ascertain the source of the dividends distributed, the researchers used a stringent criterion to identify the companies that distributed dividends from unrealized earnings: a company only meets the criterion if the amount of dividends it distributed is greater than all the realized earnings that it can distribute."
Another, no less disturbing, finding in the study is that a company's creditors do not receive any compensation whatsoever for the additional risk to repayment of the debt. This risk is not priced in the return spreads on the bonds of companies that distributed such dividends, and is not reflected in the rating for the bonds.
"…bond market investors need to demand, at issuance, covenants that limit the ability of companies to distribute dividends from unrealized earnings, or at least to demand a higher yield on bonds of a company that distributed such dividends," the study states. "Alternatively, the relevant regulators may need to limit such distributions. The findings of the research may lend support for the proposal of the Ministry of Justice and the Israel Securities Authority to amend the Companies Law, with the goal of preventing the distribution of dividends from unrealized earnings."
The study included 292 firms with marketable bonds, a quarter (75) of which distributed dividends from accounting profits, and a third (94) of which went through a debt arrangement at least once during the sample period - 2008-2013.
The study also states, "…when comparing a company that distributed dividends from unrealized earnings to a similar company that did not distribute such dividends, it is found that the probability of the former to require a debt restructuring is more than three times greater, all other things being equal. Additional examinations showed that the findings do not derive solely from already riskier companies choosing to distribute dividends from unrealized earnings before encountering perceptible difficulties."
The study finds that that distributing dividends from accounting profits significantly increases the likelihood of encountering financial difficulties, and that the rating agencies and investors are not correctly pricing this risk. The authors of the study are Nadav Steinberg of the Bank of Israel, Dr. Ilanit Gavious of Ben-Gurion University of the Negev, and Dr. Ester Chen of the Peres Academic Center.
Published by Globes [online], Israel Business News - www.globes-online.com - on June 28, 2017
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