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Dividends in a Real-World Setting. BP’s situation and dividend decision after the Deepwater Horizon accident in 2010

Essay 2016 4 Pages

Business economics - Investment and Finance

Excerpt

Introduction

“BP is one of the world’s leading international oil and gas companies.” (BP, a, 2015) BP was founded in 1908. Today, BP has its headquarters in London (BP, b, 2015). BP provides their customers with energy for heat and light, fuel for transportation and a lot more services (BP, b, 2015).

At one of BP’s oilrigs, “Deepwater Horizon” in the Gulf of Mexico, an accident occurred on 20 April 2010. A gas release and subsequent explosion cost 11 people the life (BP, c, 2010) and resulted in 4.9m barrels of oil being discharged, threatening marine life and hundreds of miles of coastline (BBC, a, 2011).

After this accident, the US government wanted BP to use the profit to pay for the Gulf of Mexico clean up instead of paying dividends to their shareholders, which put BP under intense pressure (BBC, b, 2010).

In the following text, I will reveal the benefits and drawbacks on BP paying out a dividend and the effect on their shareholders.

The irrelevance of payout policy

Miller and Modigliani (MM) (1961) proposed that in a perfect capital market, the dividend decision has no impact on shareholder’s wealth and is therefore irrelevant. Under the assumptions of a perfectly competitive capital market with no taxes, no transaction costs as well as independent dividend and investment decisions, MM demonstrated their analysis of the irrelevance of dividend policy (Peirson, Brown, Easton, Howard, Pinder, 2012, p.341).

Furthermore, MM proposed, “Investors are rational so they always prefer more wealth to less and are equally satisfied with a given increase in wealth, regardless of whether it is in the form of cash paid out or an increase in the value of the shares they hold.” (Peirson, Brown, Easton, Howard, Pinder, 2012, p. 341).

However, there is empirical evidence that when a company pays less dividend a year the share price is more likely to fall (Peirson, Brown, Easton, Howard, Pinder, 2012, p. 355). Regarding BP’s situation after the crisis, reducing their dividend and perhaps even omit paying a dividend can be resulted in a decrease of share prices which may harm BP’s shareholders.

Information effects and signaling

According to MM, the information effect can be consistent with their irrelevance theorem because “the announcement of a change in dividends provides the occasion for a change in share price, but the change in dividends is not itself the cause of the price change” (Peirson, Brown, Easton, Howard, Pinder, 2012, p.354).

BP was under intense pressure from the government and the community when the accident occurred. Both were expecting BP to use their money for clean-up, environmental remediation and economic development (Wall Street Journal, b, 2015).

In addition, BP will have to pay for claims and fines. Those costs will likely be spread over several years. This leads to an expected gearing of 23% by the end of 2013 which is below the targeted gearing ratio of up to 30% (Wall Street Journal, a, 2010).

BP’s year-end net debt in 2010 would have been about $31 billion and an extra debt capacity of about $17 billion. (Wall Street Journal, a, 2010). First year’s pretax clean-up costs would be about the same. That are the reasons why BP could have handled the costs without touching dividends, as stated in the article (Wall Street Journal, a, 2010).

Therefore, paying a dividend may give a positive signal and reassurance that BP will recover in the long-term and generate sufficient cash to be able to pay dividends. It may also provide information on management’s expectations as to BP’s future profitability (Peirson, Brown, Easton, Howard, Pinder, 2012, p. 354).

Nevertheless, paying out dividend under given circumstances may be inappropriate and can be resulted in a negative change in share price (Peirson, Brown, Easton, Howard, Pinder, 2012, p. 355). This would harm BP’s shareholders because the value of their shares would be lower due to dropped share prices.

Homemade dividends and transaction costs Examining why the reduction or omission of BP’s dividend may harm the shareholder, there is another aspect that needs to be taken into account. If BP decides against paying a dividend, a shareholder who needs additional cash has the opportunity to sell some of his shares to create a homemade dividend (Peirson, Brown, Easton, Howard, Pinder, 2012, p. 344). Independent on the payouts made by BP, the shareholder would have created his own preferred cash flow stream. Therefore, transaction costs may occur (Peirson, Brown, Easton, Howard, Pinder, 2012, p. 344).

Share Buybacks

When repurchasing shares, companies are buying back their own shares. This is a way to distribute cash to shareholders without paying a dividend (Peirson, Brown, Easton, Howard, Pinder, 2012, p. 372).

BP could have repurchased some of their ordinary shares. For shareholders such as retirees who require income from their share portfolio and therefore are expecting and relying on a dividend, it would be great news (Peirson, Brown, Easton, Howard, Pinder, 2012, p. 344).

Nevertheless, when repurchasing shares BP would have given the market a positive signal that the shares are undervalued (Peirson, Brown, Easton, Howard, Pinder, 2012, p. 362). Taking into account the intense pressure and BP’s situation described in the article, this was not the case.

Conclusion

BP omitted their dividend payout for quarter one to quarter three in 2010 (BP, e, 2015). From April 19, 2010, to June 25, 2010, BP’s share price fell from $59.48 a share to $27 a share, which is a 55% decrease (Chamberlin, 2014). On June 10, 2010, shares fell to a 13-year low (Haslett & Ehrenberg, 2015).

illustration not visible in this excerpt

Figure 1 - BP change in share prices 2010-2015 (Haslett & Ehrenberg, 2015)

Furthermore, recent news announced that BP has to pay $18.7 billion for claims spread over 18 years (Wall Street Journal, b, 2015).

Reference List

BBC, a. (2011). BP oil spill: The environmental impact one year on. Retrieved on October 21, 2010, from http://www.bbc.co.uk/news/science-environment-13123036

BBC, b. (2010). BP board to discuss dividends on Monday. Retrieved on October 21, 2010, from http://www.bbc.com/news/10291371

BP, a. (2015). BP at a glance. Retrieved on October 21, 2010, from

http://www.bp.com/en/global/corporate/about-bp/bp-at-a-glance.html

BP, b. (2015). Our history. Retrieved on October 21, 2010, from

http://www.bp.com/en/global/corporate/about-bp/our-history.html

BP, c. (2010). Deepwater Horizon accident and response. Retrieved on October 22, 2010, from http://www.bp.com/en_us/bp-us/commitment-to-the-gulf-of-mexico/deepwater- horizon-accident.html

BP, d. (2015). BP to Settle Federal, State and Local Deepwater Horizon Claims for up to

$18.7 Billion With Payments to be Spread Over 18 Years. Retrieved on October 23, 2010, from http://www.bp.com/en/global/corporate/press/press-releases/bp-to-settle- federal-state-local-deepwater-horizon-claims.html

BP, e. (2015). BP cash dividends - ordinary shareholders. Retrieved on October 23, 2010, from http://www.bp.com/content/dam/bp/pdf/investors/bp-cash-dividends-ordinary- shareholders.pdf

Chamberlin, A. (2014). A must-know guide to BP and the recent Deepwater Horizon ruling. Retrieved on October 25, 2010, from http://marketrealist.com/2014/09/bp-lost-55- shareholder-value-deepwater-horizon-incident/

Haslett, E., Ehrenberg, B. (2015). One chart showing how BP's share price never recovered from the Deepwater Horizon disaster. Retrieved on October 25, 2010, from http://www.cityam.com/219401/one-chart-showing-how-bps-share-price-never- recovered-deepwater-horizon-disaster

Peirson, Brown, Easton, Howard, Pinder. (2012). Business Finance. McGraw-Hill Australia Pty Limited.

Wall Street Journal, a. (2010). BP Should Resist Slashing Dividend. Retrieved on October 21, 2010, from

http://www.wsj.com/articles/SB10001424052748704575304575296901987387356

Wall Street Journal, b. (2015). BP Agrees to Pay $18.7 Billion to Settle Deepwater Horizon Oil Spill Claims. Retrieved on October 24, 2010, from http://www.wsj.com/articles/bp- agrees-to-pay-18-7-billion-to-settle-deepwater-horizon-oil-spill-claims-1435842739

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Details

Pages
4
Year
2016
ISBN (eBook)
9783668491953
File size
773 KB
Language
English
Catalog Number
v371068
Institution / College
University of Newcastle – Finance
Grade
3,0
Tags
corporate finance finance share bp oil crises dividend

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Title: Dividends in a Real-World Setting. BP’s situation and dividend decision after the Deepwater Horizon accident in 2010