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Monday, June 14, 2010

Should BP Pay a Dividend?

Some politicians are outraged that BP is planning to pay its previously-announced dividend. The comedians on the Communism Channel had a neat excuse. "If you prevent BP from paying a dividend, you're stealing from the grandmas and pensioners who rely on the dividend for their retirement income."

That's pretty clever! The US legal system isn't stealing from BP's executives, when they make BP payout a huge claim. They're stealing from BP's shareholders!

This illustrates the Principal-Agent problem. When executives at BP cut corners on safety, they weren't risking their own personal assets; they were risking the shareholders' assets. By cutting corners on safety, executives boosted the balance sheet and earned nice bonuses. When there's an accident, the shareholders and not the executives take responsibility for the loss.

The oil well was already behind schedule. The executives on the well were under pressure to meet their deadlines. It was costing $1M-$2M+ per day that the well was delayed. They were thinking about the bonus for meeting the well schedule, or the penalty for being late, rather than proper safety practices.

I'm agreeing with the US State thugs on this issue. It's immoral for BP to pay a dividend until the total cost of the accident is known. The claims of people injured by the accident take precedence over claims by shareholders. The State thugs in the UK are claiming that the US doesn't have the legal authority to prevent BP from paying a dividend.

From a theoretical finance perspective, paying a dividend or not paying a dividend doesn't affect shareholder returns. If a corporation pays a $1 dividend, then its share price declines by $1 on the ex-dividend date. With or without the dividend, the total return to shareholders is the same; any shareholder who prefers the dividend can sell his shares instead.

In the case of BP, there's a bankruptcy risk. This makes BP equity more like an option than equity. If there's a $1 dividend and BP later declares bankruptcy, the dividend takes away from money available to pay off creditors. If BP pays a dividend and later declares bankruptcy, the dividend payment was effectively stolen from BP's creditors.

BP has the cashflow to pay current expenses. Corrupt State law limits BPs liability, so they'll probably be able to cover all State-recognized expenses. However, there's still a lot of uncertainty. The $75M damage cap does not apply in the event of criminal negligence. If put in front of a jury, it'd be very easy for plaintiff attorneys to argue "Criminal negligence occurred!"

Another possibility is that BP's USA division could declare bankruptcy, while they continue operations in the rest of the world.

When a nearly bankrupt corporation makes a huge payout, that is effectively stealing from other creditors. For example, suppose I am the CEO of a nearly-bankrupt corporation. I have $10B in debts and $500M in cash. Suppose I hire you as a consultant and pay you $500M upfront. Then, I declare bankruptcy. The creditors may claim "Hey! That $500M belongs to us!"

When Bernard Madoff's ponzi scheme collapsed, some insiders withdrew their funds ahead of time. The bankruptcy judge is disallowing some of those payments, requiring them to be returned to pay off creditors.

Sometimes, a hedge fund faces huge losses and collapses. Insiders are allowed to redeem their shares at face amount before the losses are announced. The hedge fund manager starts a new fund, and these insiders invest in the new fund!

Corporate executives have successfully lobbied for laws limiting their liability. This encourages and rewards negligence. BP's oils spill isn't a "failure of the free market". It isn't a "failure of the free market" when State law explicitly limits compensatory and punitive damages. Limited liability incorporation protects executives and insiders. The Supreme Court capped Exxon's punitive damages for the Valdez incident, overruling the decision of a jury. Punitive damages play an important role in discouraging negligence. The Oil Pollution Act explicitly limited liability to $75M plus cleanup costs.

Some politicians want to retroactively raise the cap. That would be an "ex post facto law" or a "bill of attainder". You can't declare an action a crime after the fact ("ex post facto"). The cap should never have existed in the first place; it was a compromise so that oil lobbyists would support the Oil Pollution Act. You can't pass laws that target one person ("bill of attainder"). The only corporation affected by the retroactive damage cap increase would be BP.

One offensive bit is "Let's put a tax on all oil, to pay for the cleanup and compensate the victims." That makes everyone *BUT* the criminal pay for the cost of the accident. There was no incentive for Shell to have better safety practices if all oil is now taxed to pay for the accident.

BP executives did the right thing, when they cut corners on safety. If damages are capped at $20B and you save $200M per well, then it pays to be cheap on safety if the chance of accident is less than 1%. Removing damage caps and limited liability incorporation would change this calculation. BP lobbyists and other oil lobbyists are the source of laws that limited liability. It's cheaper to hire lobbyists than spend money on safety. That is the nature of State-sanctioned crime.

The true economic cost of the accident is probably $1T or more. The actual payout is capped by corrupt State law. It seems that will be around $10B to $50B, less than BP's pre-accident market capitalization. Also, some money won't be paid out until 5-10+ years from now, after all lawsuits are resolved. The Exxon Valdez Supreme Court decision didn't occur until 20 years after the accident. In the meantime, many plaintiffs died; the cost of the verdict was not adjusted for the inflation that occurred in the meantime.

Some people are saying "The victims won't get much money each. The only people who will get rich off this are the lawyers." Various lawyers are falling all over each other to be the lead plaintiff in the inevitable class action lawsuit. That is a defect in the legal system, that some lawyers will get an unearned huge bounty after this accident.

Corrupt State law caps compensatory damages and punitive damages. Limited liability incorporation gives executives a free put option to declare bankruptcy and cheat their creditors. This encourages and rewards negligent behavior. Hiring lobbyists is more profitable than doing honest work.

1 comment:

Anonymous said...

>The only people who will get rich
>off this are the lawyers.

You only have to read the newspapers to see numerous examples of completely bogus civil law cases that spring up. Courts take several years and hundreds of thousands of pounds to decide on whether saying something like "I'm not convinced by what they say" is libel, fair comment or the truth.

Then there are the other type of cases which revolve around whether a person owns the copyright for a word such as "cat" or the shape of a letter such as "s".

Then there are the trademark cases between companies with totally different names in different companies.

There are cases about whether an old war veteran that has had a shed in his garden since the end of World War II, actually owns the end of his garden. Clue: he does as he has a fence enclosing the shed for decades. The lawyers managed to kill the old man with a threatening letter in the case.

All these cases are bogus. Some never see the inside of a court room.

But they take months to years to settle and the lawyers make money out of them.

The lawyers don't do anything useful and suck money out of productive industry.

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