If the Board of Directors elects to proceed with a dividend issuance, it should consult with the investor relations officer (IRO) in developing a dividend policy that coincides with the Board’s long-term expectations for the company.
An excellent initial decision is to begin with a relatively small dividend. Issuing any dividend, no matter what size, creates an expectation among a company’s new income-oriented investors that a dividend of the same size or larger will be issued at regular, predictable intervals. If the Board were to authorize an excessively large dividend, the company might quickly find itself struggling to support a large and continuing cash outflow. By instead beginning with a smaller dividend, the IRO can likely issue a series of press releases that point out the company’s ongoing ability to gradually support a larger dividend – which is excellent news for investors, and which will likely lead to a gradual increase in the company’s stock price.
Another argument in favor of a small initial dividend is to consider the worst-case scenario – where a company cancels its dividend. This implies a cash crisis, unless the IRO can present a cogent case that the company is investing the cash in an activity that will result in outsized profits. The trouble is that the current set of investors are primarily concerned with income, not growth, and so they will likely sell their stock even if the company’s reason for diverting cash from dividend payments is entirely valid. If there is indeed a cash shortfall, then the income investors will very likely sell their stock. When this happens, the stock price will probably drop considerably, until it appears to be a bargain for value investors. This new group of investors will then buy stock at a much lower price, and count on a company turnaround to restore profits and presumably increase the price of their shares. Another problem with a cancelled dividend is that the IRO may be placed in the uncomfortable position of continually responding to investor queries about when the dividend will be reinstated – resulting in a continual stream of negative announcements. In short, a small, sustainable dividend mitigates the risk of a dividend cancellation in the future.
One type of dividend to be avoided is the special dividend. It does nothing to permanently increase the stock price, since it represents a one-time outflow of cash, for which the stock price will promptly increase (when the dividend is announced) and then fall (after it is paid). Investors will assume that the special dividend will not be repeated, so they will not bid up the price of the stock in expectation of any additional special dividend on some unannounced date in the future.
Once the Board decides upon the correct dividend size, it should work with the IRO to communicate this information to investors. A simple statement of the amount and timing of a single dividend is not a sufficient degree of investor communication. Instead, the statement should itemize the expected timing of dividend issuances and the basis for the amount of dividends to be paid in the future, so that investors can more accurately calculate the value of the stock related to its stream of future dividend income. When explaining the basis for the amount of future dividend payments, it helps to be as detailed as possible. For example, indicate the exact percentage of company earnings or cash flow to be paid as dividends.
The company’s overall theme of investor communications will likely change as part of the dividend policy, since the IRO must now reposition the company as being an income investment, rather than a growth investment. This calls for a complete re-evaluation of the message to investors, which will require the input of the entire management team.
A useful best practice to offer investors is a dividend reinvestment plan (DRIP). This plan allows the company to plow the dividends of consenting investors back into more company stock, usually at a discount from the market price, or at least without any brokerage commissions. This may be perceived by investors as a significant benefit, and may result in a higher than average level of investor retention (as well as less cash outflow to pay for dividends).