How to align your board and management to achieve your strategic goals

This article, prepared by Deloitte Human Capital, provides “Board Members” and “Executive Leaders” with a practical approach and framework to evolve their relationship and optimise governance effectiveness.

If you have any questions, contact Gert de Beer at gedebeer@deloitte.co.za, Garth Bell at gbell@deloitte.co.za or Carla Clamp at cclamp@deloitte.co.za or visit the Deloitte Collective Leadership website. 

Boards and Management renew their vows – A new era of collaborative leadership

A renewal of vows is a symbol of a renewed commitment between two parties. Sometimes parties renew their vows to celebrate relationship milestones and reaffirm their commitment to each other; other times, they renew their vows after a challenging period in their relationship, when their commitment to each other and their relationship has been tried and tested.

Arguably, the Board–Management relationship has been through a challenging time. It suffered a protracted period of scrutiny and tension due to various scandals over the past decade resulting from lack of oversight and accountability (Enron and Worldcom being the most notorious). This has resulted in corporate governance reform across a number of national and international jurisdictions, with a specific focus that Boards and executive Management be held increasingly accountable for the actions of their organisations. This heightened accountability has put a strain on the Board’s relationship with Management, a strain that has intensified during the recent financial crisis and which has resulted in the increase in Board oversight and involvement in corporate strategy, risk management, executive compensation and achieving sustainable, high-performance cultures. Although increased Board scrutiny on these dimensions is likely to improve business performance and better serve the interests of the shareholders, managing such a large agenda is challenging, and Boards cannot do it in isolation. The reality in this day and age is that Boards must work with Management to both inspire organisational performance and address the expanding accountability agenda. A significant challenge in this regard is the Board’s ability to engage and collaborate in a way that does not compromise its objectivity and independent oversight role.

To achieve the desired Board–Management relationship, a change from the status quo is most likely required for most private and public enterprises. For those organisations that aspire to strengthen longer-term performance and optimise governance effectiveness, the starting point is to understand the current governance culture and the Board–Management relationship, and how they need to evolve.

With this strategic opportunity in mind, this paper will provide Board members and executive leaders with a practical approach and framework to evolve their relationship and optimise governance effectiveness. Furthermore, it outlines an approach to collective leadership which should ultimately enhance organisational performance, increase shareholder value and address the need for increased accountability for inspiring and optimising the commitment of employees to strategic direction and operational performance.

Would you like to learn more? Download the Deloitte article –  How to align your board and management to achieve your strategic goals

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Filed under: Executive Leadership, Finance, Information Technology, Talent & Human Capital, accountability, boards, collaborate, Corporate Governance, corporate strategy, Deloitte, executive compensation, governance, management, risk management, shareholders

Do Dividends Matter?

Introduction

Does a company’s decision regarding its dividend distributions have an impact on the value of its equity? In short, do dividends
matter?

Dividends are irrelevant

In terms of classic finance theory, a rational investor should be indifferent between receiving a cash dividend from a share, or having the company retain the cash and re-invest it at the weighted average cost of capital. In this way, a stock trading at 10/share cum dividend (meaning the dividend belongs to the buyer of the share and not the seller) would trade at R9/share ex dividend (meaning the dividend belongs to the seller of the share and not the buyer), once the R1/share dividend has been paid, and the investor would be equally happy holding the R10 share without the prospect of a dividend. This school of thought, known as the dividend irrelevance proposition, has strong theoretical backing in a world where taxes are ignored, securities are fairly priced, and the cost of issuing new stock is negligible. An investor is indifferent to receiving returns in the form of dividends, stock appreciation or a combination.

Dividends do matter

However, in practice, the relationship is not always so simple. Several asset managers have stated their preference for dividend paying shares, as it is often indicative of a company which is stable and has matured to the point where sufficient free cash flow is being generated to justify a cash distribution. Certain types of investors, such as pension funds, have a need for regular  distributions (to cover either administration costs or the monthly income needs of its clients, especially the elderly) and have a
preference for dividend paying stocks. The market often takes a dim view of companies which are sitting on large cash reserves, especially where management has neither a credible plan for the investment of the funds nor the intention to return the funds to shareholders. It is not uncommon for management teams in this position to squander excess cash resources on overpriced acquisitions, or ventures not related to the core business of the company.

Investors prefer a consistent (and preferably increasing) regular dividend pattern, and building up a good track record in this respect can help a company achieve confidence in the management team which translates into an increased share price. Indeed, accounting earnings can be manipulated but cash dividends are cash. The level of the dividend payout ratio would typically be determined after examining the stage of the company’s life cycle. Mature, established business would have far higher dividend payout ratios than start-up or fast growing companies (which may not pay dividends at all for several years).

In industries which are cyclical or in the event that an unusual gain is realised by the company which is unlikely to be repeated, it
makes sense to return the surplus funds to shareholders by manner of a special dividend. The occasional use of a special dividend allows the company to maintain a consistent regular dividend history, without sacrificing the flexibility of maintaining an optimal capital structure.

Several companies which had historically been consistent regular dividend payers and decided to forego or reduce such a dividend (BP and Anglo American come to mind), have seen their share price decline following such an announcement, not necessarily because of the cash retention but rather the signal sent to the market that senior management and the directors foresee difficult times ahead and are choosing to retain the cash. This uncertainty about the future translates into a weaker share price. Dividend policy may send a signal to the market which is more powerful than the actual amount of dividend paid (or withheld), because management and the directors are the ultimate company insiders. They have intimate knowledge about the company’s affairs, and are thus effectively communicating non-public information by their dividend decisions.

Total shareholder return

According to Standard & Poor’s, the dividend component was responsible for 44% of the total shareholder return of the last 80 years of the index. Our internal research reveals that, measured over a 10 year period on the JSE, the equivalent statistic is 36% in dividends.

Thus, to the investor, dividends constitute a significant portion of their investment return.

Conclusion

Empirical studies have not provided a conclusive link between dividend policy and valuation. The chief consideration in determining a suitable dividend payment policy should be the availability (or lack) of suitable reinvestment opportunities which have a positive net present value (NPV). If such opportunities exist, the company should reinvest its surplus funds into these projects, failing which the cash should be returned to shareholders by way of a dividend. As an alternative, a share buy-back could also be considered if the company’s shares appear undervalued.

Article compiled by Johann Rawlinson (Senior Manager at Deloitte Corporate Finance) and David McDuff (Partner at Deloitte Corporate Finance).

Filed under: Executive Leadership, Financial Services, dividends, equity vallue, Investment, shareholders, Valuation