Shareholder remuneration: What strategy to adopt ?

Shareholder remuneration is sometimes an issue as it is left to the discretion of companies (within the legal framework). Indeed, they have several means, several strategies to remunerate shareholders and in the best case attract new investors and increase the value of its shares. The questions that arise are therefore the following: how to remunerate shareholders who have “sacrificed" capital to invest in your company? What strategy should be put in place to remunerate them at the fair value of their investment? When and how often should dividends be distributed? We will first look at what the law allows in terms of dividend distribution, before discussing the different strategies and the advantages and disadvantages of each.

We will focus here on the legal framework for dividend distribution, which can sometimes be modified to allow companies some more flexibility. To be able to distribute dividend, a company must first be profitable. From the moment it makes a profit, it has two main choices: either distribute this profit to shareholders or place it in reserve. In all cases, the company must hold minimum reserves as required by law. The profit must therefore exceed all costs in order to be allocated in dividend payments. Then, the decision on whether or not to distribute dividends is taken at the annual ordinary general meetings to be held six months after the end of the financial year. At these meetings of shareholders and partners, companies can also make certain amendments to the regulations that allow them some flexibility: the company can choose not to allocate the profit directly and add it to the company's capital, to deduct from reserves and not from the profit to distribute dividends to shareholders, or to change the method of remuneration (by paying dividends not in cash but in shares, for example).

With regard to the frequency of dividends, they are usually paid annually, within 9 months after the ordinary annual meeting. 

We therefore see here that the legal framework imposes a certain caution on companies. On one hand, I initially found this legal framework too restrictive and which could hinder some shareholders in their investments, but on the other hand, it requires shareholders (who are members of the board of directors and therefore participate in meetings) to make the right choices for the benefit of the company and not for their personal gain. I therefore believe that this “win-win" relationship is beneficial both for the company and for shareholders, provided that the institutions responsible for supervision (such as audit firms) have sufficient power to enforce the laws.

We will now discuss the different possible strategies for a company to distribute dividends. 

First, the policy of paying stable or increasing dividends at a constant annual rate: this is one of the most widespread policies since it offers shareholders stable returns (with a possible constant increase). An example of this type of dividend distribution is the Danone company, whose compensation per share has increased by €0.8 in 10 years, at the same time as its profits. 

Then, another strategy is to establish a distribution ratio. In other words, the company defines in advance a fixed percentage of the profit that will be redistributed to shareholders. This is an advantage for shareholders if the company is in a growth phase and is making significant profits.  This type of remuneration could be illustrated with Nexity's policy, which has established a payout ratio since a few years.

However, the high volatility of dividends (since it is impossible to accurately predict the profits that will be realized in the following year) may discourage shareholders from investing in such a company. In my opinion, this is a risky strategy that can turn out to be a two-edged sword: either the company makes large profits and dividends will only be higher, or shareholders will not find their happiness in this company.

Finally, the company can opt for the residual policy; it is a long-term oriented strategy that remunerates shareholders with the remaining profits after having covered all the company's equity financing needs. Indeed, the company considers it more advantageous to reinvest its profits rather than redistribute them to shareholders. In concrete terms, this takes place in 3 stages: definition of the investment budget for the coming year, financing of investments according to the company's optimal debt ratio (if the ratio is 30%, the company will finance itself at 30% by debt and 70% in equity); finally, when profits exceed equity requirements, the surplus is distributed to shareholders. Otherwise, they do not receive dividends. I find this model to be a good compromise since the company's investment is favoured and at the same time it can be very profitable for shareholders. Thus, companies mainly have the choice between 3 fundamentally different strategies: one that is rather simple to approach for shareholders who do not necessarily wish to invest in the long term and whose operation is rather simple, one that focuses solely on the company's profit, which only functions on its performance, and the last one that seems less profitable for shareholders but which in the end may be preferable for the company and for investors who wish to invest money in the long term.

In conclusion, shareholder remuneration can be based on several schemes depending on the type of company and the relationship that the company wants to maintain with its shareholders. However, these theories are based on the fact that dividends are intended to remunerate shareholders, while increasing investor demand for the company to increase its value. Modigliani and Miller (1961) challenge these assertions with the following theory: it is not the dividend policy itself that will determine the company's valuation but the investment policy, since the company's value is given by the cash flows resulting from high value-added investments and not by the dividend policy directly. Thus, even if these investment policies are widely used, we may wonder whether they are not ultimately just a reflection or a vague indicator of the value of companies.