By Manish Bhandari, CEO, managing partner, Vallum Capital Advisors
Indians save a lot but invest mostly in gold and real estate and very little in equity. This must change.
In the case of equities, retail investors have to rely on the kindness of strangers (brokers or advisors) to scan a profitable investing opportunity. Corporate misgovernance and lack of enforcement by agencies do not help either. A radical solution is to make a certain dividend payout ratio compulsory. The controlling shareholders coalition creates agency issues such as reluctance to distribute cash flows, complex business structures and voluminous yet opaque information for minority shareholders. Investors are left with capital market vagaries as the only measure of wealth creation.
A compulsory payout of the profits will ensure accounting profits are aligned with the cash generated by the company, representing a realistic picture of accounts. This would encourage long term investment and channelise saving in the productive financial assets of equities. Our policy makers can be generous to provide an incentive to corporates in the form of Allowance for Corporate Equity (ACE), making dividends on equity capital tax deductible ( a charge on equity capital) coupled with a compulsory dividends pay out policy, around 25 per cent ACE, allows deduction on shareholder funds (long term rates of Govt. Securities) from corporate taxability, an incentive for generous payouts and good compliance.
A close look at the results last fiscal of the constituents of BSE 500 Index (excluding 59 government companies, 21 loss making Companies and 48 MNCs due to policy conflict and smoothing of special dividends to get factual annual payout picture), shows an interesting fact. The average pay out is around 20.6 per cent but this data is skewed by a few companies having very high dividend pay outs. On an aggregate, companies accounting for 50 per cent of the total profit of above mentioned universe pay just around 9 per cent of profit as dividends while keeping balance 91 per cent at disposal of controlling shareholders. ACE coupled with compulsory dividend would incentivise companies towards fair accounting, eliminate debt bias, and reduce risk to the banking system in the country.
The international experience of compulsory dividend payout and ACE or its variant has been very encouraging. Belgium, Chile, Greece, Columbia, Venezuela and Latvia have some variant of ACE system working while Austria and Italy adopted ACE for some time and abandoned it in favor of broader corporate tax reforms. Italy has readopted ACE in Dec 2011. Brazil has successfully implemented ACE coupled with compulsory dividend since 1996, a model that should inspire India. Australia has set up a committee to estimate impact of ACE introduction in their economy. Recently, Chinese Security Regulatory Commission (CSRC) has expressed strong opinion about low dividend payout for listed companies and has floated a working paper on this subject. Arecent IMF working paper indicates that various government bodies across Europe are debating some form of ACE in order to reduce the debt bias that has contributed to financial crisis.
Let me preempt the criticism of a proposal for compulsory dividends. First, it reduces the ability of the corporate to reinvest, even as the cost of raising equity is high, especially for smaller firms. A Brazilian study finds this had no impact on a firm’s long term reinvestment capabilities. Moreover, cost of equity improves dramatically, as the inflow from institutional investors spreads across market capitalization thereby increasing the investible universe, which is usually quite concentrated in large cap stocks. Secondly, its impact on public revenue outweighs the benefit . The statistics shows that our sample companies generated PAT of $ 43 billion, paid tax of $ 13.5 billion and distributed dividends of US$ 8.8 billion for the FY2012. The cost of implementing ACE with compulsory dividends to the public exchequer, in terms of lower tax collection, would be up to $2.5 billion per annum, a meager number, considering the gains associated for all the stakeholders.
This policy would bring benefits of attracting money by investors for good corporates, increased investments financed by equity, higher wages and economic growth, urgently needed by the country. Indian authorities have to wake up before the competition among nations intensifies, to attract global long term capital for financing the country’s need. If India responds only during crises, then let’s not waste the opportunity in implementing this.