SEBI’s Proposal for a Dividend Policy

Last week, media
reports indicated
that SEBI is considering imposing a requirement on listed
companies to come out with a dividend policy that will compel (or at least
nudge) profitable cash-rich companies to distribute their profits to
shareholders. The introduction of more stringent requirements on companies to
state their dividend policies will introduce a great deal of transparency on
this count. But, at the same time caution must be exercised not to curb the
business decision-making process of companies which is left to the management
and boards who possess the necessary knowledge and expertise.
The analysis must
begin with the separation of powers between the board and the shareholders. Since
boards are vested with the powers of management, they are naturally best-placed
to determine whether the profits of the company are to be distributed or to be
ploughed back into the business. Hence, within the scheme of company law, the
board propose dividends which are then to be approved by shareholders.
Shareholders effectively possess only a veto over the decision on dividend.
They can reject the dividend or reduce its rate, but they cannot increase the
dividend over and above what the board has proposed.
Given this
scenario, if SEBI’s proposal brings about transparency as to dividend
declaration by companies through the need for specifying their policy, that
would be beneficial to the markets. Shareholders then have the necessary
information about dividend declaration without necessarily impeding the
flexibility of the boards to adopt any policy as they deem fit. But, if SEBI’s
diktat is likely to impose obligations on boards to distribute excess cash
through profits, that would be undesirable.
The question of
compelling profitable companies to distribute their hordes of cash is not a new
one: it has been daunting global companies like Apple for the last few years
with activist
investors applying pressure
on them to distribute profits either through
dividends or buyback of shares. The use of market mechanisms to compel
companies to distribute profits is understandable. Investors may either impose
discounts on companies that horde cash profits, exit such companies or even put
pressure on companies through activist investors. They may in turn be aided by
informational intermediaries such as proxy advisory firms.
What SEBI must
avoid is a prescriptive approach towards dividend declaration, in terms of
imposing rules or guidelines on when to distribute profits, or how much. Historically,
the law has operated in somewhat converse fashion. Companies are not allowed to
distribute all their profits in the form of dividend, and are compelled to
transfer some part of the profits towards reserves, as it were “to save for a
rainy day”. This philosophy continues in section 123 of the Companies Act, 2013
as well. So, now to force companies to distribute their profits would be at
variance with this principle. Hence, as dividend declaration is dependent upon
the cash needs of the companies business it must be a matter left to the
management and boards to decide (of course with the required level of
transparency and checks and balances required by corporate law and governance
norms).
The usual concern
when companies do not distribute profits is that they may be instead be
utilised in a manner that adversely affects minority shareholders, such as by
enriching management (e.g. executive compensation) or the controlling
shareholders (e.g. related party transactions). However, other mechanisms in
corporate law effectively address these concerns of transactions that enrich
insiders at the risk of outside shareholders. Imposing tighter regulation on
dividend declaration is an area where the regulator must tread carefully and with
circumspection.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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