Shanghai targets dividend development

Shanghai Stock Exchange is offering incentives to spur improved domestic payout ratios, but a change in investor thinking is not expected overnight.
Shanghai targets dividend development

Shanghai Stock Exchange is urging local firms to raise dividend payouts in a drive to promote healthy market development, although its impact is not expected to be felt for some time.

The bourse just released draft guidance in which it pledges to support company refinancing or M&A activity either when they pay over 50% of profit as cash dividends, or the proportion of the dividend to net assets beats one-year interest rates from the People’s Bank of China.

As an extra incentive, companies with a dividend payout ratio of less than 30% would be required to publicly disclose the reasons for the low ratio.

Firms can choose one of four methods to pay dividends: fixed amount; fixed payout ratio; additional cash (on top of fixed amount or payout ratio); and residual cash (deducting capital expenditure from profit and paying out the difference in cash).

The exchange has thrown the process open to public consultation and will accept feedback until August 30. The draft guidance is due to become effective from January 1 next year.

Edward Huang, strategist at Haitong International Research, confirms that the dividend payout ratio of China’s listed companies has been much lower than the global average over a long period of time.

Over the past 10 years, the average dividend payout ratio for firms listed on the Shenzhen Composite Index is 29.36%, and 44.76% for the Shanghai Composite Index, compared with a global average of 60%, according to Haitong data.

“The low dividend of China’s stock market has not only reduced its attraction to foreign investors, but also led to unfavourable investment habits of focusing on capital gains and neglecting dividend payments,” says Huang.

He expresses the view that a high cash dividend payout ratio would encourage more varied types of funds to invest in China.

However, Tony Liu, head of international business at Rongtong Fund Management Company, notes that domestic fund managers do not typically take cash dividends into account.

“Although portfolio managers generally associate companies that have steady dividend payout histories with better corporate governance, they don’t see the performance of these stocks as consistently better than companies which don’t pay dividends,” he notes.

To date there are no active domestic mutual funds that focus on high-dividend stocks in China. As such, Liu suspects the concept of high-dividend investment will take a long time to take root.

“China’s domestic stock market has far less participation from institutional investors compared with developed markets,” he reflects. “Most equity investors pay more attention to capital gains than dividends, so it’s a chicken-and-egg problem.”

But Liu says when dividends begin to provide a visibly meaningful income stream, investors will learn to differentiate firms with reliable pay-out histories, which in turn will encourage more companies to pay dividends. “The investment pattern will change, but it will take time,” he says.

Further, with China’s economic growth in gradual decline and more companies moving to a mature stage of development, capital expenditure for business expansion is widely forecast to drop, creating a favourable environment for firms to raise their cash dividends.

However, Liu questions whether state-owned-enterprises will in fact ever care about the interests of minority shareholders, given that their majority shareholders are government agencies.

“Company management may not be motivated to reduce capital expenditure and reward equity investors by paying dividends,” adds Liu.

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