Remember stakeholder economics?

It’s been a long time since Will Hutton introduced us to the idea of a stakeholder. Back in the last century, the Blairite vision was for a society where the needs of a shareholder were balanced with the needs of an employee and companies were run fairly, with suppliers and other “stakeholders” being in the mix.

The word even gave rise to a type of personal pension “the stakeholder pension” which introduced us to the concept of the charge cap and limited the capacity of pension providers from over distributing sales commissions to advisers.

This vision of corporate harmony played well at the time but was lost in the maelstrom of the financial crash and the rise of austerity politics under the coalition and subsequent conservative Governments. Stakeholder pensions were the forerunners of the workplace pensions used for auto-enrolment but they failed to achieve the inclusivity they were designed for. We would need to reform the distribution of DC savings schemes as well as their design before we had a functional system that worked for all.

The TUC ask do dividends really pay our pensions?

The TUC along with two think-tanks , have produced a report which examines who benefits from shareholder returns and the extent to which dividend payments from UK companies are a significant source of income for UK pension funds.

It concludes that only a tiny proportion of UK dividends and buybacks accrue to UK pension funds.

The chart shows how pension funds (the yellow ribbon) have been reducing exposure to UK pension funds for 30 years. The “de-risking” following mass closure accounts for the sharp declines since 2006, but the longer term trend represents the desire of schemes to diversify from a UK-centric investment strategy (and the willingness of overseas investors to pick shares up).

In recent times, the Pensions Regulator has been calling on companies to prioritise the payment of deficit contributions over dividends, it can do so without punishing pension scheme funding, because the schemes it regulates are no longer dependent on those dividends. Ironically , pension schemes now compete for – rather than depend on – free corporate cash-flows.

Dividends do not pay our pensions.

So if UK pension funds aren’t benefiting from dividends – who is?

There is increasing public interest in the rising amount of money UK companies pay to their shareholders through dividends and share buybacks and the potential opportunity cost – in terms of workforce wages, investments in R&D and building resilience against external shocks, such as COVID 19.

• Dividends have risen as a share of pre-tax profits at FT350 companies between 1997 and 2020, while investment has fallen over the same period;
• Shareholder returns at the FTSE 100 grew by 56 per cent between 2014 and 2018, while average earnings grew by just 8.8 per cent (both nominal); and
• It is relatively common for companies to pay dividends that exceed their total profits; this happened in 27 per cent of cases in the FTSE 100 between 2014 and 2018.

Analysis of official statistics shows that the proportion of UK shares directly held by UK pension funds fell from almost one in three in 1990 to less than one in 25 by 2018 – a decline of over 90 per cent. Most UK shares are now held by overseas investors. The proportion of UK shares owned by overseas investors rose from 12 per cent in 1990 to 55 per cent in 2018.

Is investing for equity income – a productive use of capital?

One of the justifications given for high levels of dividend payments is that ‘they pay our pensions,’ because people’s pension savings are invested in the stock market. This repot politely points out that this is not the case. If anything, UK dividends are paying pensions in overseas countries, though the underperformance of UK stocks relative to global markets suggests that investors would be better served by UK management focusing on production and capital expenditure.

The priority placed upon shareholders in the UK’s corporate governance system
encourages companies to place shareholder returns above wages or long-term
investment. And executive pay is often linked to levels of shareholder returns, creating
a direct incentive for company directors to pay dividends even when not justified by
performance.

It’s hard not to see “Pension Fund dependency on dividends” as camouflage for companies rewarding shareholders and senior management – rather than investing for the future. This is not a model for long-term productive capital. It confuses the purpose of equity and bond markets.

It is hard to see the UK economy as a beneficiary of overpayment of dividend income.

Sid is not funding his retirement from British Gas dividends

The vision of a shareholding democracy that preceded Will Hutton’s is ancient history. “Tell Sid”, the campaign to get British Gas shares out to everyone happened in 1985.

Sid is now old enough to be drawing his pension but he is unlikely to still own his shares (let’s hope he sold them before Centrica’s fortunes changed). The report points out that direct holdings of publicly quoted shares are concentrated on a small proportion of affluent and financially sophisticated people. Sid may have been told, but he didn’t listen.

Sid never really got it.

If Sid benefits from the dividends paid by British companies, it is indirectly through the pooled funds he is invested in through workplace pensions. The report points out that before he gets his cut of the dividends, financial intermediaries have had theirs.

So Sid’s retirement is not dependent on dividends from shares, his retirement is not dependent on funded pensions, Sid’s retirement is dependent on state benefits

The financial service industry is responsible for less than a fifth of income paid to pensioners in the UK. Sid is given scraps from the table.

What does this mean?

The findings of the report  demonstrate a minimal and diminishing link
between the fortunes of the UK’s largest companies and the pensions of working
people. UK pension funds account for a small and declining proportion of UK
shareholdings. Individual shareholdings are overwhelmingly concentrated amongst the
very rich.

And yet we see dividends rising as investment on Capital Expenditure falls

Dividend income is denying the long-term investment that equity capital is designed to provide. It is benefiting the wrong people in the wrong way.

Time for change?

The report concludes with a call to action which is clearly aimed at a new Government, or at least those who are thinking about what its manifesto might be.

It is time for this to change so that working people benefit fairly from the success of the companies they work for and claim a fair share of the value they create. This will require corporate governance reform alongside policies to promote collective bargaining.

Strip out some of the rhetoric and this is a 21st century update on Will Hutton’s 20th century call to action.

Good for those in work

I will not list the specific measures called for by the TUC, but they are designed to address this cult of the dividend and ask why firms paying high dividends are doing so. This blog focuses on pensions and how we pay them and sees the TUC measures as driving long-term value for those in long-term pension plans. So I support the TUC’s measures listed at the end of the report.

People who want to play a long-term part in the companies they work for, will benefit from the TUC’s approach to dividend de prioritisation

Good for those in retirement

The high-income approach to investing is of course favored by many wealth managers who see “natural yield” as the means to manage drawdown.  But at a time when longer term investment horizons are being encouraged, perhaps we should be thinking beyond “income stripping” , when thinking about our retirement planning.

And maybe those who value UK stocks should be re-appraising the value given to companies who keep provide artificial buoyancy to their share prices, by over-rewarding shareholders and under-investing in production.

Retirement is a long-term business and so is investing.