Monday, June 14, 2010

Tempest in a Teapot

From this side of the pond, it's hard to avoid bewilderment at the British charges of Anglophobia over the reaction to the BP oil spill. For any Briton reading this, let me assure you that the level of anger here would be at least as great if ExxonMobil had done what BP did: create the worst environmental disaster in American history, have by far the worst safety record (by a factor of  a hundred or so) of any major oil company, consistently understate the size of the problem, lag in organizing the cleanup, and so on and on. Anglophobia? In your dreams. Who do you think you are, the French?

BP, we are told, is a British icon, which only adds to our confusion.  GM, Harley Davidson, Apple, Coca Cola, maybe Hilton, are American icons. Oil companies are not American icons. I can't help suspecting that there's some projection going on: you just know that if Exxon oil were washing up on the beaches of Scotland we'd be hearing about uncouth, money-crazed, market-worshiping American cowboys.

Intellectually, the most interesting part of  this uproar has been the fury at the suggestion that BP cut its dividend. For many years, a big puzzle in academic finance theory has been why firms pay dividends at all. If companies simply held on to their cash, those retained earnings would be reflected in a higher stock price, which would be a capital gain for stockholders, with big tax advantages. Yet most companies pay dividends, and the market generally regards an increase in the dividend as good news about the company and a decrease as bad news.

I won't take you through all the ins and outs of this topic, but some of the leading theories don't help us to understand the vehemence of the reaction. One theory is that dividend increases are a way for management to signal optimism about the company's prospects. They can't just say they're optimistic, because talk is cheap and no one would believe them. By paying a larger dividend they can show that they expect to have more cash in the future. Yet surely no one now could take a cut in BP's dividend as a signal of anything, given the political pressure on management to do it.

Another theory is that paying dividends is a way to keep management from wasting money on unprofitable spending, which they would be more apt to do if they had a lot of cash lying around. But since it's already clear that BP will be spending a lot on cleanup, and that any dividend cut will be temporary, it's hard to believe that investors are worried that management will fritter away the cash not paid out in dividends.

Anyway, stay tuned. BP's board is supposed to make a decision soon about the next dividend, and we'll see what happens to the stock price. It beats looking at pictures of dead pelicans.

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