Coronavirus Led to Dividend Cuts Among Highly Leveraged and Low Profitability Companies

The sharp and sudden shock to economic prospects and financial markets caused by the coronavirus pandemic led certain companies to change their existing dividend policies.

High leverage and low profitability were the leading factors that drove companies to suspend dividend payments. Companies with the largest negative stock returns prior to their dividend declaration date were also more likely to have suspended their dividend, according to an analysis by the Centre for Economic Policy Research.

The pandemic and its associated shelter-in-place orders have had a massive impact on solvency and liquidity for companies across a broad range of sectors. This has resulted in a sharp increase in the premium on access to cash and a substantial increase in the cost of paying dividends for companies with greater financial distress. To ensure survival, many companies focused more of their attention on short-term capital preservation. Suspending dividends was one of the actions companies took to preserve capital.

During normal economic conditions, investors typically interpret dividend suspensions and reductions as a negative sign of company growth prospects. This, in turn, has a strongly adverse effect on stock prices. However, the report’s authors say that the pandemic altered the way investors interpret changes in companies’ dividend policies, with many investors viewing the suspension of dividends in some cases as a necessary precaution and prudent action.

During the pandemic, companies that suspended their dividends saw large negative abnormal returns following the declaration date, while companies that substantially reduced their dividends experienced large positive abnormal returns. The positive market reaction to companies that have announced dividend cuts can be attributed to previous expectations that the company would completely eliminate their dividends. Investors have interpreted retaining at least some dividends in this situation as a sign of financial strength, thus resulting in positive abnormal returns.

Compared to the market crash of 2008, the coronavirus pandemic saw a big shift in drivers of companies’ decisions to change dividend policies. Company size and cash holdings have had less of an impact on the decision to suspend dividends due to the pandemic. Companies with less profitability and more leverage were highly likely to suspend their dividends. In addition, companies with poorer stock market performance were more likely to suspend their dividends due to the pandemic. Companies and sectors most adversely affected by the outbreak of the coronavirus are, in turn, most likely to beneﬁt from a suspension of dividends.

Source: “Dividend Suspensions and Cash Flow Risk During the COVID-19 Pandemic,” by Davide Pettenuzzo, Riccardo Sabbatucci and Allan Timmermann; Centre for Economic Policy Research, June 2020.