Case Berkshire Hathaway Dividend Policy Paradigm

Case - Berkshire Hathaway Dividend Policy Paradigm
Introduction
Berkshire Hathaway (BH), as a model of value-driven growth, advocates non-
dividends, reinvesting proceeds into existing businesses and acquiring more
businesses which are not related to existed. Buffett, chairman of the BH, also
believes that the stock repurchase plan can return the initiative to individual
shareholders. This article will compare the characteristics of cash dividends,
stock repurchases, and no dividends. Then, combine BH financial statements
to discuss the feasibility of BH and Buffett's views and give recommendations.
Analysis
1) Cash dividend
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Enterprise may consider issuing cash dividends when it has sufficient existing
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or retained earnings. The advantage is that regular cash dividend policy is a
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positive signal for company’s profitability. The response in the open market is,
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the rise in stock prices, which in turn enhances the market value of the
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company. In addition, shareholders can use dividend reinvestment plans to
purchase additional stocks in the open market without incurring financial
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costs. However, the disadvantage is that the distribution of cash dividends will
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weaken the net income, which in turn will reduce the total value of the
company’s assets. This may limit the development of the company and affect
long-term strategic planning.
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As one of the no cash payment way, the stock split has increased the number
of shares outstanding while also ensured that the market value of the
enterprise unchanged. Therefore, the stock price will decrease with the stock
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split. Although this method will not affect the capacity at the accounting level,
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it may be regarded as a signal that the stock price is overestimated, which

may cause other risks.
2) Share buyback
The advantage of cashless stock buyback is that it can adjust the problem of
under-pricing of stocks. It makes cash inflows greater than cash outflows to
obtain a positive NPC, increases earnings per share, dilutes the earnings
generated when exercising stock options, and increases leverage without
borrowing. In addition, the number of shares decreased in the market will
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reduce the impact on liquidity. The most notable example is in a bear market,
where the company delayed stock price declines through stock buyback.
Compared with the dividend policy, the irregularity and opaque characteristics
of the stock buyback may bring negative emotions to the market. Moreover,
institutions and insiders who have a large amount of information initiative may
use the above characteristics for profit.
Discussion
Buffett's strategy of not paying dividends is feasible. It can be discussed from
the following aspects:
1) Law and tax
The U.S. stock market does not mandate dividends, so BH does not have to
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pay dividends. Based on the current US tax policy, dividends are invested in
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Based on Tax policy centre (2016) and Tina (2020) reports, the tax rate for
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capital gains is 0%, 15% or 20%, which is lower than ordinary income and
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most of the time Short-term capital gains tax (graph 5).
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In addition, ordinary dividends and qualified dividends have different tax rates:
ordinary dividends are taxed as ordinary income, and qualified dividends are
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taxed at 0%, 15%, and 20% (TurboTax, 2019). As mentioned above, most BH
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stocks holders are institutions and insiders, and based on the stock prices of
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BRK-A and BRK-B, the dividend may create lot of taxes.

2) Transaction cost
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Based on TurboTax (2019) reports, the average annual transaction cost of US

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mutual funds is 1.44%, which includes broker fees, securities transaction tax
(STT), stamp tax, service tax and other fees. Therefore, high-frequency large-
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value transactions may incur very high transaction fees.

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3) Enterprise Development
It can be seen from Berkshire Hathaway's financial report (Graph 3) from
2013 to 2017 that BH's earnings per share (EPS) continues to rise, from 7.9 to
18.22, indicating that profitability is improving. It is worth noting that, from
2016 to 2017, it almost doubled. Based on Buffett's strategy of not paying
dividends, BH's net assets and retained earnings are very high.
4) Investor preferences
BH prefers investors with low dividend preference. According to the data, as
of the beginning of 2018, among the types of investors in BRK-A and BRK-B,
institutions and insiders accounted for 89% and 66%, respectively. They have
professional advantage, and shareholding ratio is larger. It is more inclined to
postpone taxable income to avoid taxation reasonably, and the indicator of BH
outperform (Graph 1 to 2) makes these investors more inclined to continue to
hold BH stocks.
In addition, non-dividend distribution can reduce investor losses and
intermediary profits caused by information asymmetry.
Conclusion
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The article mainly introduces the conflict of interest between the company and
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shareholders. Based on the fact that bank interest rates are lower than the
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inflation rate, and that BH ’s dividend distribution will not affect investment, BH
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’s strategy of continuing to refrain from paying dividends for a total of $ 115.95
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billion in cash and cash equivalents at the end of 2017 has caused
controversy. In addition, Buffett insisted on using the price 1.2 times higher
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than the book value as the repurchase price in the stock repurchase, which is
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far from the fact that BH stocks are often traded at a premium of 1.7 times.
Recommendation
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According to graph 1 to 2, the market value and book value of BH are not the
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same in all years, which may cause the ratio of market value and book value
to change. Therefore, as a BH shareholder, you can refer to this ratio to
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choose: if it is less than or equal to 1.2, the repurchase policy is more

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attractive; if it is greater than 1.2, then the cash dividend policy is better.
The company should continue to maintain its current policy. In addition to the
successful historical investment, from the BH’s cash flow statement from 2013
to 2017 in graph 4. The net cash outflow in 2016 is much higher than the total
net cash inflow in other years. Combined with the balance sheet and profit
statement, the company It is indeed an opportunity to purchase, invest and
finance. In addition, policy changes and the popularization of financial
knowledge have made investment increasingly difficult. For example, the new
crown pneumonia spread around the world early this year. The travel ban
imposed by the United States has allowed Buffett to reduce its shareholding in
the aviation industry.
References
US Department of the Treasury, Office of Tax Analysis. 2016. Taxes

Paid on Capital Gains for Returns with Positive Net Capital Gains, 1954–
2014. Washington, DC: Department of the Treasury. Retrieved from
https://www.treasury.gov/resource-center/tax-policy/tax-
analysis/Documents/Taxes-Paid-on-Capital-Gains-for-Returns-with-Positive-
Net-Capital-Gains.pdf
A, Gerald. 2005. Capital Gains Taxation. Urban Institute Press.

Retrieved from https://www.taxpolicycenter.org/briefing-book/how-are-capital-
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gains-taxed
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Burman, Leonard E. 1999. The Labyrinth of Capital Gains Tax Policy: A
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Guide for the Perplexed. Brookings. Retrieved from
https://www.brookings.edu/book/the-labyrinth-of-capital-gains-tax-policy/
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TurboTax (Oct. 31, 2019). Taxes on Ordinary and Qualified Dividends.
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eFile. Retrieved from https://www.efile.com/ordinary-qualified-dividends-tax-
rates-stock-income/
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T, OREM. (April 7, 2020). 2019-2020 Capital Gains Tax Rates — and How
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to Calculate Your Bill. Nerdwallet. Retrieved from

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https://www.nerdwallet.com/blog/taxes/capital-gains-tax-rates/#calculator
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Appendix
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Graph 1
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Graph 2
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Graph 3
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Graph 4
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Graph 5
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Case - Berkshire Hathaway Dividend Policy Paradigm

it may be regarded as a signal that the stock price is overestimated, which

BRK-A and BRK-B, the dividend may create lot of taxes.

Based on TurboTax (2019) reports, the average annual transaction cost of US

value transactions may incur very high transaction fees.

choose: if it is less than or equal to 1.2, the repurchase policy is more

US Department of the Treasury, Office of Tax Analysis. 2016. Taxes

A, Gerald. 2005. Capital Gains Taxation. Urban Institute Press.

to Calculate Your Bill. Nerdwallet. Retrieved from

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