The Financial Reporting Lab, which has been set up by the Financial Reporting Council to improve the effectiveness of corporate reporting in the UK, published a report at the end of last year on the disclosure of dividends and investor expectations in this regard.
The report, entitled ‘Disclosure of dividends – policy and practice’ sets out the results of the FRC Lab’s discussions with investors on what they want to know about dividends and focuses on dividend disclosures which both companies and investors consider can improve.
The findings of the report can be summarised as follows:
Dividend policy disclosure
Investors consider that good dividend disclosures should answer the following questions with regard to policy:
Why has the company selected its dividend policy? Both equity and debt investors would like to understand how the cash generated by a company is allocated and why this allocation is appropriate. Good policy disclosure therefore includes: (i) how the policy relates to the company's business model, strategy and capital management strategy; (ii) how the policy is to be implemented and any inherent discretion; (iii) how capital is maintained; (iv) the process the board has been through to set the policy; and (v) the risks and constraints associated with the policy, including any significant judgements and assessments;
What will the policy mean in practice? Investors identified two main types of policy, progressive and payout ratio, and wanted these terms to be clarified. If the policy is described as progressive, investors want information on the level and period of progression. If the policy is defined in terms of a payout ratio, where dividends are set as a percentage of a defined metric, investors want information on the defined basis for the ratio, its rationale, and whether a minimum, range, target or specified ratio is adopted. Investors also want to understand the timeframe over which the policy is expected to operate; and
What are the risks and constraints associated with the policy? Investors want to understand the nature of the material risks and constraints that the board considers in setting the policy. For example, for some companies, the binding constraint may be related to availability of cash, gearing levels, debt covenants or regulatory capital requirements. For others, it may be distributable profits.
Disclosure of practice under the policy
Investors consider that it is important to be able to determine what was done in practice to deliver under the policy. They therefore suggested disclosing the key judgements and constraints considered in applying the policy (including the dividend resources i.e. cash and the amount of the distributable profits) and highlighting any changes made to, or departure from, the policy.
While most investors considered that the disclosure of dividend resources was helpful in circumstances where the ability of the company to pay dividends is, or might be, insufficient relative to the level of dividends indicated by the policy, some investors believe that distributable profits are always required to be disclosed (although the FRC states it considers that the Companies Act 2006 does not require companies to separately identify distributable profits on their balance sheet).
A further point made in the report is that dividend disclosures are often spread across a wide range of company communications, making it difficult to locate information and understand a coherent message. Investors would like all disclosures on dividends to be grouped together, or for links to be drawn between the disclosure elements. In addition to annual report disclosures, it is suggested that companies disclose up-to-date and historical information on policy and practice on their websites.
Finally, investors have also said they want disclosure of the circumstances in which companies expect to pay special dividends or buy back shares, and whether they are in the best interests of shareholders. In respect of buybacks, investors are looking for disclosure of the maximum price the company is prepared to pay, and the target minimum rate of return. Summary information on the weighted average cost of shares bought, total cost, and the effect on key metrics for buybacks undertaken during the year, is also helpful to assess the interaction between buybacks and management performance metrics. Retail investors, in particular, also want boards to explain their assessment of how buybacks benefit shareholders.
FRC Lab considers that the issues raised in the report are likely to be relevant to all listed and AIM companies, irrespective of size and dividend policy (formal or not). It concludes that information on dividend policies and practices is important to a wide range of investors and that disclosure of both policy and practice provides useful information in assessing both the case for investment and stewardship in holding the board to account.