Another cliff

At the end of 2012, many investors received an unexpected gift...special dividends paid by companies in anticipation of changes in the income tax laws. Because of the so-called “dividend cliff”, 483 companies paid a new or increased dividend on a “one-time” basis or paid their 2013 dividends earlier than planned (prior to December 31, 2012). This is the highest number of special dividends paid since 1955 and almost four times the number paid in 2011.

A few highlights (or lowlights, depending upon your perspective):

• Oracle paid an $0.18 per share dividend on December 21, 2012 that represented its planned dividend payment for the second, third, and fourth quarters of 2013. This dividend totaled $867.5 million, of which Chief Executive Officer Larry Ellison received almost $200 million.
• Costco announced a $3 billion special dividend, borrowing $3.5 billion to finance it. Its stock price increased by 5% in the two days following the announcement.
• While not a dividend, Goldman Sachs provided its executives with early vesting on restricted shares worth $65 million.

How did shareholders benefit? Based on the 2012 tax rate for dividends (15%) and the maximum tax rate in 2013 (20%), Costco’s dividends would save its shareholders $150 million in taxes. Based on Oracle’s dividend, the tax savings to Larry Ellison alone were almost $10 million. (2013 tax rates on dividends as high as 43.8% were discussed prior to the final resolution).

Do these dividends make sense? On one hand, if these dividends were already committed to be paid in 2013, companies provided greater value to their shareholders, both through receiving the dividend earlier and a greater after-tax benefit of the dividend. On the other hand, if companies decided to increase the dividend, pay a one-time dividend, or otherwise deviated from their capital plan, questions as to whether the dividend provides long-term value for shareholders must be asked. Should the company have increased its capital expenditures, held the cash for expansion or acquisitions, or repurchased some of its shares instead? Will shareholders react negatively in the future if dividends revert to pre-2012 levels or are not paid in the future? Only time will tell whether these special dividends were worthwhile.