Why a Company Would Choose to Cease or Never Pay Dividends

Company dividends are a fundamental concept in shareholder relations, representing a portion of corporate profits distributed to shareholders. However, companies have the discretion to decide whether to distribute dividends based on various financial and strategic considerations. In this article, we explore the reasons behind a company ceasing to pay dividends and why some may never offer dividends in the first place, focusing on the implications for both the company and its shareholders.

Factors for Ceasing Dividends

Dividends are typically distributed following a profitable year, but this is not a mandate. The decision to pay dividends lies within the discretion of the board of directors, who can choose to distribute the entire profit, retain a portion for future growth, or issue no dividends at all. One of the primary reasons for ceasing dividends is often a financial crisis, when a company needs to conserve cash to mitigate losses or pay off debts.

Financial Crisis and Ceasing Dividends

A significant example is PGE, the California-based electric company, which ceased dividend payments following a major financial and legal setback. In 2017 and 2018, PGE was found to be responsible for numerous fires causing damages of over 5 billion dollars. After announcing the cessation of dividends, PGE's common stock price plummeted from around $55 to $10, while the preferred stock dropped from approximately $26 to $22.8. For companies with a decades-long history of dividend payments, discontinuing these distributions is often seen as a sign of extreme and imminent financial distress.

Not Paying Dividends in the First Place

It's important to distinguish between a company that has never paid dividends versus one that ceases to do so. New and growing companies often choose not to distribute dividends to reinvest profits into business expansion. These companies prefer to grow through organic means, using retained earnings to fuel growth rather than paying out to shareholders.

Strategic Reasons for Not Paying Dividends

Companies might also choose not to pay dividends if they believe a reinvestment of profits would lead to greater long-term value. For some investors, the lack of dividends is acceptable since it allows the company to retain cash for internal growth. Moreover, the lack of dividends doesn't necessarily imply financial trouble, as many investor-focused companies prioritize stock appreciation over dividend payouts.

Market Implications

The cessation of dividends generally has a significant impact on the stock market. When a company with a long history of dividend payments stops, it often results in a sharp decline in stock value. As PGE demonstrated, divesting shareholders may lead to substantial financial loss. Similarly, for companies that choose never to pay dividends, the stock value may not decline as drastically, but investors might view the lack of dividends as a sign of future growth potential.

Conclusion

Whether a company ceases to pay dividends or never pays them at all, the decision can have far-reaching implications. For shareholders, understanding these reasons is crucial for assessing the financial health and growth potential of a company. While some investors prioritize dividends for their income and tax benefits, others prefer stock growth, making it essential for companies to communicate their dividend policies transparently to maintain shareholder trust.