Pain or gain: dividends v capital deployment

With New Zealand’s economy slowly recovering after a long period of financial stress, boards will need to carefully consider how to handle pressure from their shareholders for dividends against the preservation of capital as a buffer against risk or deploying capital to seize opportunities.  

This may result in some difficult conversations around the board table and even more difficult conversations with shareholders.

Rights to dividends

As a starting point, shareholders have no general right to demand a dividend. Whether a dividend is declared will be determined by the board, which will include considering the size of the dividend and when it should be paid, based on the company’s profitability and financial position.

Additionally, a company must meet certain legal requirements under the Companies Act 1993 (Companies Act), including that the company remains solvent after payment of the dividend. Essentially, if paying a dividend would put a company’s financial health at risk, the company is not permitted to pay the dividend.

Dividend policy

While shareholders do not have a right to a dividend, it is not uncommon for a company to adopt a dividend policy, which stipulates the board’s objectives in relation to dividends.

These policies can be set by the shareholders or by the board, and can vary based on a company’s financial health, growth strategy and shareholder expectations.

It is important to note that unless such policies are set out in the constitutional documents, these policies are not binding on a company and, in any event, a board would find it difficult to declare a dividend where it would risk contravention of the Companies Act.  

Directors’ duties

In addition to solvency requirements, there is a direct line between a director authorising dividends and their fiduciary duty to act in good faith and in the best interests of the company.

This fundamental duty will influence a director’s decision about declaring dividends. In particular, it requires directors to consider the company’s long-term health, sustainability and success when making decisions.  

If directors authorise a dividend that is not legally justified or breaches the solvency test, they may be held personally liable for breach of their duties. Other consequences may include penalties, fines or other sanctions under the Companies Act, or possible derivative action from shareholders.

Capital deployment

With boards having to consider an ever-broadening range of factors, the question of whether to declare a dividend, or use capital for other means, is becoming more and more complex.

While this is not an exhaustive list, some current trends that might be discussed by a board include:

• Digital transformation/AI: A company may need to digitally transform and/or adopt AI technologies (which could lead to enhanced operations, customer experiences and decision-making). If a company chooses to adopt new technologies, what will this look like, how much will it cost and what benefits will be achieved?
• ESG: While the acronym ESG may have lost favour with some companies/investors, the principles that sit behind it remain topical: in particular, the drive to develop sustainable business models. Regardless of whether a board considers ESG is relevant, a company may find they are forced to comply with ESG principles because of their customers and/or suppliers.
• Expansion/investment: Depending on the life cycle of a company, the current economic conditions may provide opportunities for vertical or horizontal growth through mergers, acquisitions or joint ventures. Such investment may introduce scale, new markets or complementary/cutting-edge technologies and tools.
• Workforce development: Given New Zealand’s low productivity statistics, a company may want to use excess capital to target investments in workforce upskilling, training programmes and evolving the workforce to be a strategic, agile and adaptable resource.
• Cybersecurity and data privacy: As the risk of cyber and data threats increases, ensuring strong cybersecurity and protecting data is essential. This is becoming increasingly vital due to the growing scale and complexity of cyberattacks, including those carried out by a rising number of state-backed actors. With this in mind, a company may wish to invest in technology and processes to protect against these risks.

Weighing it up

As a consequence of the current economic climate and the increasing number of factors that boards are grappling with, the decision of whether to declare dividends is becoming a more complex and difficult exercise.

In our experience, good boards will:

• • Have a clear strategy
  • Work through all potential uses of funds prior to declaring dividends
  • Clearly document their discussion and decision-making processes
  • Communicate their decision to shareholders, including why they have reached it

Regardless of the outcome of these decisions, the potential of having some long-awaited headroom, and the problem of how to allocate it, will surely be welcomed by boards.