While the whole world will celebrate & welcome 2013 with parties galore, most of the US citizens may have little to cheer about as far as the tax rates on their incomes are concerned. This is because their earnings are likely to be taxed at a substantially higher rate if the US is unable to take a U-turn and avoid the fiscal cliff before 31st December 2012.

Fiscal Cliff

The lower tax rates gifted by the George Bush Administration, and extended under duress by Barack Obama in 2010, are going to expire in a few days from now. This is especially true for Incomes like dividends, which are most likely to be taxed at nearly thrice the rate prevalent today. 1st January 2013 onwards, the “qualified dividends”, which are presently enjoying a special rate of 15%, are likely to be taxed as ordinary income at around 43%. The fact that dividend tax is a tax on taxed income (distribution of net profits) makes the effective tax rate even more atrocious.

To avoid getting hit by this impending tax hike, several companies have recently come out with higher dividends, special dividends and early dividends which will be paid before 1st January 2013. Several companies like Wal-Mart Stores, Inc. (NYSE:WMT), Las Vegas Sands Corp. (NYSE:LVS) & Tyson Foods, Inc. (NYSE:TSN) have either preponed or declared special dividends to avoid the post 31st December scenario.

The biggest beneficiaries of this preponement & special dividend payouts obviously are the founders or the majority owners of the corporations. Needless to say, the majority owners are the ones who decide if an early or a special payout is to be made or not. Thus if Oracle Corporation (NASDAQ:ORCL)’s makes an early dividend payout, it will obviously help Larry Ellison the most as he owns more than 1.1 billion shares. Similarly, Sheldon Adelson will save hundreds of millions of dollars in tax when his company Las Vegas Sands Corp. (NYSE:LVS) pays a special dividend of $2.75 per share on 27th December. One has to give due credit to these majority owners as they take the maximum risk by investing substantial amounts of their wealth into the future of these organizations. But the question is, does this risk, entrepreneurial or otherwise, entitle the “real” owners to take decisions which accrue direct financial benefits to them?

In answering this question, one can obviously consider this as a one-time benefit granted by the board to help the ordinary shareholders pay less tax and hence retain more dividends. One can think that, at least in the immediate term, the shareholder’s wealth is being “maximized” by this early payment of dividend.

However, the important question is whether this payout is only a preponement or has the DPS been increased to abnormal levels. If it is just a case of early payouts, the reduction in cash of the company is what it would have been with or without the fiscal cliff.  Thus the benefit of being quick about releasing the payment will benefit the shareholders in the short term without having any adverse impact in the long term. If, however, the amount paid is higher than what would have been paid in normal course, then the scanners can be pulled out to examine the payouts on a case to case basis. One has to ascertain if the company indeed has the financial strength to pay a higher or a special dividend without compromising on the future stability of the cash flows or the growth story of the organization.

The point is, whether paying higher dividends is the best that could have been done with the cash. If the answer to these questions is a no, then there may be hints that this short term “world is about to end” mentality has hit the “non-Mayan” corporate world also. It would also allude to the possibility that the board has effectively helped the major owners siphon off more cash from the company at the expense of the long term prospects of the organization.

Another facet of this dividend bonanza is that ultimately the board is paying out more because they expect the US to go over the fiscal cliff. This obviously has an implicit corollary that some form of recessions is about to hit the world’s largest economy. Then why should the corporations pay out more than what they would normally do? Should they not save for the rainy days ahead? Bear in mind that these dividend tax “sops” would not benefit all shareholders, as several are long term players or retirement savers which are unaffected with tax increases anyway. In any case, this one-time tax avoidance will not make the ordinary share holder rich forever. In fact, companies with lower cash will obviously have a lower ex-dividend valuation which will reduce the value of individual portfolios.

To conclude, one has to accept that the corporate world is controlled by the big guns. They control the decision making and sometimes they may get biased towards taking decisions for personal gains. The surge in dividend payouts to beat the fiscal cliff deadline may benefit the shareholders in the short term. However, if the dividends is more than what is justified keeping in mind the “impending recession” or the financial strength of the company, then this is definitely a moral and corporate governance issue.

The shareholders should not be led to believe that these actions by the majority owners are in their best interests in all the cases. The minority shareholders should be ready to raise their voices at the appropriate forum, if it becomes obvious that these payouts were to the detriment of the future strength of the company. Ultimately, shares are valued at future earning capacity of the company which, in turn, depends in judicious use of the available capital. If paying dividends is the only “opportunity” that the management can think off, then perhaps the time has come to get fresh ideas on board.

The world did not come to an end on 21st December and the US economy will not collapse on 1st January. The concept of a “going concern” has to be on the mind of the board members at all times. Short term benefits should be continuously weighed against the long term wealth maximization principles. Any deviation from this accepted philosophy would invite suspicion and scrutiny.