Dividends: Under the Microscope
Thomas Toomse-Smith, Project Director, Disclosure Lab, FRC | October 23, 2017
For investors, information about dividends (both current and future) is critical to decision making. Dividends relate to expected return in the short term but are also relevant to investors’ understanding about the longer term direction of a business. However, dividend policy, strategy, and practice are often areas where disclosure could be improved.
In November 2015, the Financial Reporting Council (FRC) Financial Reporting Lab sought to change this by releasing Disclosure of Dividends – Policy and Practice. The report was based on input from 19 companies and 31 investment organizations. It suggests enhancements to dividend policy disclosures to ensure they are specific about the parameters and inherent flexibility of the approach taken to dividends and explain why that approach is appropriate. In applying the policy, the report recommends the disclosure of judgements made and a scaled approach to describing available cash and distributable profits.
Micro or macro change?
During Q2 of this year, the Lab looked at how 313 companies in the FTSE 350 implemented investors’ suggestions.
- 132 companies implemented some of the disclosure recommendations in the Lab’s report.
- The most noticeable change was the inclusion of a reference to distributable profits or distributable reserves with 58% of the FTSE 100 making some level of disclosure (up from 40% in 2015), and 48% disclosing:
- The amount of distributable profits/reserves of the holding company; or
- The elements of distributable profits/reserves that are not distributable; or
- Reference to distributable reserves as sufficient or significant.
- Change was less evident in the FTSE 250 with, for example, only 30% of companies making some disclosure on distributable profits or reserves.
- Some companies (across the FTSE 350) had improved disclosure of the risks to dividend or the factors that they considered in setting the dividend policy.
- Some companies (across the FTSE 350) had enhanced descriptions of what the stated dividend policy meant in practice, although companies could make further improvements in this area.
Scope for improvement
Through the course of the review, the Lab also identified some areas where companies could take the opportunities to push disclosures even further.
Key areas included:
- Identifying the explicit links between dividend, principal risks, and viability: The Lab’s upcoming Risk and Viability report (Q4 2017) will note the importance of connections between the business model, risks to the business model, and the potential impacts on viability. Investors consider that the dividend strategy should be an element of all three, either as one of the outcomes (business model), something that may be impacted by risks, or as an important part of potential mitigation response (viability).
- Enhancing disclosure on constraints: Either by providing details on the sustainability of the dividend or by clarifying the level of distributable profits/cash or another constraining factor (especially in the FTSE 250).
- Explaining more fully what policy means in practice: Either by explaining what a “progressive” policy (or equivalent description) means regarding growth (i.e., what makes it progressive) or clarifying how “pay-out ratios” are calculated.
- Enhancing understanding of structure and process: By specifying where profit is generated in the group, how profits might flow to the top company, and any relevant constraints (current or potential) to that flow.
The Lab is encouraged by the continuing improvements made by companies identified in the study and are particularly pleased to see companies responding to investor calls to add clarity to disclosures around distributable profit/reserves. The implementation study demonstrates how Lab projects can be useful for both companies and investors.
Best practice continues to develop. Companies should continue to enhance disclosures in this area and this year’s reporting season is the perfect time to consider this. More details can be found in the implementation study (including example disclosures) which is available on the Lab’s web page.