cfo.com

Print this article | Return to Article | Return to CFO.com

Dividends Bounce Back

A record number of companies, including Microsoft, Best Buy, and RadioShack, issue dividends; FASB hands out a FIN 46 reprieve; bank-tying practices leave the GAO in a knot; tax practitioners exit the Big Four in droves; and more.
CFO Staff, CFO Magazine
December 1, 2003

Since the 1980s, companies in the S&P 500 that pay dividends to their stockholders have been a vanishing breed. But this year, that trend has turned around—in a big way. Although the numbers change on a daily basis, as of the end of October, 19 companies on the index had initiated dividends this year, including such well-known names as Best Buy, Microsoft, and RadioShack. "Standard & Poor's has been tracking the steady decrease in dividend payers since the 1980s, and this year marks the first substantial increase in two decades," says equity market analyst Howard Silverblatt.

Not only are more firms paying dividends, more are increasing their dividend rates as well: the number of firms hiking their rates jumped more than 9 percent from last year, to 193 from 177. And 26 of those boosted their rates more than once this year. "We're not talking about small numbers; the average is 19.5 percent," declares Silverblatt. United Technologies, for instance, pumped up its rate 10.2 percent in April and another 29.6 percent in September. Citigroup cranked up its rate 11.1 percent in January and 75 percent in July. And Kinder Morgan elevated its rate 50 percent in January and 166.7 percent in June.

One of the driving factors is the federal tax cut that took effect in May. Praxair Inc., a Danbury, Conn., producer of industrial gases, for example, increased its dividend rate twice this year—13.2 percent in January and 25.6 percent in October—in large part because of that legislation. "It caused us to reconsider increasing the overall payout ratio to a higher level," observes CFO James S. Sawyer.

With the legislation—which reduced the dividend tax rate to 15 percent—dividends have gained a new cachet in the executive suite, says Sawyer. When dividends were taxed as ordinary income, he explains, there was an incentive to buy back stock rather than pay dividends, because the tax rates on capital gains and dividends were the same. Now, while dividends and long-term capital gains are taxed at the same rate, he says, "there's a slight advantage to dividends over capital gains, because short-term capital gains are taxed at a higher rate."

Silverblatt expects dividend rates to continue to rise for the foreseeable future. "The earnings are there, the ability to pay is there, and the yields are historically low," he says. —John P. Mello Jr.

Follow the Directions

Calendar-year companies have until New Year's Eve to comply with Fin 46 and put variable-interest entities (formerly special-purpose entities) on their balance sheets. The rule—a response to Enron's depredations—was supposed to take effect in the third quarter, but the original deadline was extended on October 8, after it became clear that some companies were still puzzled.

The will-o'-the-wisps of the business world, VIEs are ethereal paper companies used to hold assets for such purposes as structured financing. But the same murky characteristics that made them useful for hiding Enron's debt also make them tricky to define, which forced the the Financial Accounting Standards Board to issue clarifications on Halloween.

"It's complicated to apply an economic concept to these structures," explains FASB chairman Robert Herz, "but we had to do it because trillions of dollars were being hidden off the books." Asked if recent restructuring by banks to keep VIEs off their books was in keeping with the underlying principle of Fin 46, Herz noted that banks "took further steps to deconsolidate the risk, so at least directionally, they went in the right direction." —Tim Reason

The Ties That Bind

Do commercial banks illegally tie the availability of corporate credit to purchases of investment-banking services? Perhaps, concludes an October report by the General Accounting Office.

The GAO found little documentary evidence of tying, because, not surprisingly, "credit negotiations are conducted orally." It also noted that companies are reluctant to report tying, both for fear of retribution and because they aren't sure when it's illegal.

Yet the 56-page report recommended improving the enforcement of antitying laws and was critical of a recent joint study by the Federal Reserve and the Office of the Comptroller of the Currency, which found no unlawful tying and concluded that banks had taken adequate steps to prevent it. The GAO said the bank regulators failed to broadly analyze bank transactions for evidence of tying and didn't talk to corporate borrowers at all.

"We were surprised they could come to that conclusion without talking to any corporate practitioners," says James A. Kaitz, CEO of the Association for Financial Professionals. In March, an AFP survey of 700 members found that 56 percent of companies with more than $1 billion in revenues had been denied credit or had their credit terms changed because they didn't award the bank other financial business.

Tying credit to traditional banking services is not illegal, and the AFP drew no legal conclusions from its survey. However, of the five services that companies said their banks had tied to credit availability, only one, cash management, was not an investment-banking service.


Still, the fact that many corporate borrowers don't understand when tying is legal and when it isn't is a challenge for federal regulators, the GAO report noted. And recently released guidance from the Fed, intended to clear up the confusion, may have made things worse. It noted that banks may make credit contingent on the purchase of other products—including investment-banking services—if the customer is offered a "meaningful choice" that also includes one or more traditional bank products.

But what if a customer already buys those traditional products elsewhere? "That's the problem," says Kaitz. In that case, he says, the bank shouldn't be allowed to deny credit if the company declines the additional products. The meaningful-choice concept, he says, needs to be better defined. "It is a whole new term of art that the Fed has come up with." —T.R.

When Tax and Audit Don't Mix

The lawyers are leaving—again. Lured away from law firms in recent years by the roster of top corporate clients at the Big Four accounting firms, tax attorneys now are finding those coveted clients scared off by the Sarbanes-Oxley Act of 2002. As a result, some lawyers are now bolting the Big Four and returning to traditional law practices.

"Sarbanes-Oxley hasn't precluded accounting firms from doing tax services, but it certainly has affected the breadth of services they can do for their audit clients," says attorney Michael F. Solomon.

In September, he and six other tax lawyers left PricewaterhouseCoopers after just two years to join the Washington, D.C., office of law firm Shaw Pittman LLP.

Although Sarbox allows accounting firms to provide tax services, they are not permitted to provide advocacy work or legal services to audit clients. That means they can't represent those clients before the Internal Revenue Service or in tax court. And even tax services that are not specifically prohibited to audit clients must still be approved by a client's audit committee.

Apparently, many audit committees prefer not to make that call. "There seems to be a continuing drumbeat that auditors who provide tax services to audit clients are not independent—even though Congress and the [Securities and Exchange Commission] carefully considered the issues and concluded to the contrary," PwC CEO Samuel A. DiPiazza Jr. testified at a September hearing of the Senate Committee on Banking, Housing, and Urban Affairs. He said PwC has seen about a 20 percent drop in audit client using its U.S. tax practice, adding, "evidence shows that the trend is continuing."

"We hope it's a trend," says Barbara Roper, director of investor protection at the Consumer Federation of America, who was critical of Sarbox and the SEC for not simply banning auditors from providing tax services. "Given some of the recent scandals—Sprint comes to mind—careful audit committees are concluding what Congress and the SEC should have concluded, which is that tax-planning services are fraught with potential conflicts."

Stephen B. Huttler, managing partner at Shaw Pittman, says he's received a "deluge of résumés" from lawyers at the Big Four, and he plans to continue expanding his firm's tax practice.—T.R.

Finding Stealth Expats

Quick: do you know where your employees are? What may seem like a human-resources concern can become a finance problem when companies lose track of staff scattered around the globe. U.S. workers on assignments abroad pose a significant tax risk if they haven't taken the appropriate steps before going overseas, says Peter J. Dolan, global practice leader of KPMG's international executive-services practice. And the number of these so-called stealth expats is increasing, he says, as companies trim costs from their expatriate programs.

Authorities outside the United States may view the presence of an expat worker as a "permanent establishment" under local law; therefore, all the revenues he or she generates are subject to local tax as well as U.S. tax. If a high-level employee is abroad for several months or years, the numbers add up, says Dolan. In fact, Marc Bohn, vice president of benefits and compensation at PerkinElmer Inc., a maker of analytical instruments, estimates that lack of planning for an executive's overseas assignment can cost a company an additional $200,000 a year in tax liability and other costs.

There are penalties for the employee as well, says Dolan; foreign governments may tax pension contributions, which are taxed again upon withdrawal. In the worst-case scenario, an employee overseas without the right papers may receive a visit from police.

These costs are easy to avoid, says Dolan. The risk occurs when managers send employees abroad without alerting HR or financial management. Standard expat programs have become less appealing as companies cut costs, so managers offer better deals—and usually a higher dollar figure—to key employees, and send them off without going through the necessary official procedures.

In some cases, managers may think they're saving the company money by sending employees on extended business trips rather than formal assignments, says Kay Kutt, regional vice president at Paragon Decision Resources, a relocation-services company based in Danbury, Conn. But "a lot of costs are below the waterline," she says. "Companies need policies that are creative enough that people are willing to work with them," says Dolan. "And they need a zero-tolerance policy with regard to going outside existing expatriate guidelines."


Bohn agrees that a flexible approach is key. "It's very difficult, because every country has a unique set of issues," he says. But even reducing an employee's time abroad by a few months can help the company steer clear of significant tax penalties. —Kate O'Sullivan

Choose Your Weapon

When the edict finally comes, companies will have their choice of methods to value their stock-option expenses. In October, members of the Financial Accounting Standards Board said they would not require a particular valuation method.

One reason for the flexibility: FASB is leaving open the possibility that a better idea may emerge. "Some believe...technology and knowledge will come out that might lead to the creation of a new method," says board member G. Michael Crooch.

So if FASB specifies that companies must use the binomial method, for example, it would preclude them from using any new method unless the board revises its standards.

In addition, Crooch says FASB doesn't want to require firms to use the more-elaborate binomial method in cases where—because a firm doesn't grant many options, for example—the result would not differ greatly from the more commonly used Black-Scholes model.

Although the board prefers the binomial approach (it factors in more data and allows firms to more closely model their own situation), it plans only to call for firms to use a minimum of six inputs—those required by Black-Scholes.

Jeffrey Peck, lobbyist for the International Employee Stock Options Coalition, which opposes the expensing of options, says he found the FASB announcement shocking. "What FASB seems to be saying is...we still haven't come up with a model that works, so we'll let you pick and see if a better one emerges," he says. But Paul Library, disagrees. "FASB is all about handling the tools of good accounting to companies so they can do it themselves, rather than dictating what they should do," he says.

But will such freedom mean executives will search for the lowest possible valuation, to minimize the impact on earnings? "The new rules governing audit committees should prevent too much abuse," says Hodgson. Moreover, the FASB guideline will require "economically reasonable" assumptions, says David Larcker, accounting professor at the University of Pennsylvania, as opposed to arbitrary estimates. —K.O'S.




CFO Publishing Corporation 2009. All rights reserved.