The right of taxation vs the right of ownership

Governments hold the right to tax you.  Although most people would find the alternative distasteful, Government's holding a percentage ownership over you is actually a weaker right than the power to tax you.  A Government's passive right to a percentage of dividends you pay yourself is equivalent to the passive rights of a minority shareholder.  Under Modigliani–Miller theory, the government should be passive between the 2 choices.  A company that reinvests what it would otherwise pay in taxes, theoretically grows its accumulated profits more, and so has more funds available to pay investors and government when it pays.  The theoretical time adjusted return to government is identical for a 30% tax rate and a 30% ownership rate.

From the enterprise's point of view, it offers no real new tax avoidance opportunities.  It just greatly simplifies actions.  Instead of depreciating assets over their lives, enterprises simply use the natural cash based effects of their actions, and massively complex accounting rules designed to determine yearly tax obligations are no longer necessary to satisfy government obligations.

From an individual point of view, a government partial ownership would be almost equivalent to a progressive consumption tax:  Simply make all investment tax deductible, but raise progressive tax rates substantially.

The right of taxation vs the right of ownership is roughly comparable to the right of demanding specific regular dividends vs the passive right to claim a proportional amount of dividends when the tax payer decides to pay himself.

Under natural finance, the ideal tax regimes would be to tax salaries, benefits, bonuses, capital gains and dividends a flat 10%, while not taxing interest income.  There would be a progressive tax on total consumption, with a rebate of the 10% (salary/capital) tax for those consuming under, say, $20k/yr.  The reason for not taxing interest income under natural finance is that it is determined by perfect markets, and non discretionary:  If you are earning more interest than you deserve, someone will buy your loan away from you.  All other benefits and compensation are discretionary agreements.  Corporate taxes would be replaced with passive ownership benefits.

Stock vs Cash Dividend - The 3rd choice

Variable Dividends (or Fixed Yield Dividends) are a cash dividend that is equivalent choice to a fixed fractional stock dividend.  A fixed fractional stock dividend of 1/10th or 1/40th of a share has a variable cash dividend equivalent of 1/11th or 1/41th of the stock's market value.  The cash value of the dividend is variable with the stock price, which makes the dividend yield fixed.  So even if corporations don't pay as high a dividend as shareholders deserve, they can pay more when stock price is doing well, and less when it is doing poorly.  So can afford a higher target payout ratio, and smooth out stock price fluctuations by providing investors with a mechanism to hold low and sell high.

While all investors should be disappointed with management's primacy of self agendas over their contractual mandates, I recognize that there are far greater evils in this world.  Living with the reality of corruption of mandates to shareholder value,  and deceptions to investors regarding shareholder rights, the continued health and capitalization of the corporation does benefit other direct stakeholders (management, employees, customers).  Yet a higher target dividend payout is possible through variable dividends without compromising the health of the company.

A 3rd choice is possible to boost target payout rates much higher.  Issuing a loan option instead of or in addition to the cash dividend option provides a way for the company to issue high dividends without reducing corporate assets at all.  Issuing a loan, retains the same earnings power for the company.  The interest benefit is a shareholder benefit if the loan is issued as a dividend.

A queued soft loan is a superior alternative in every way to a bond loan for both investors and the honest fair-minded corporation.  Soft loans have a certain priority to payment that can not be worsened for investors, and so corporations can benefit from lower financing costs associated with providing a better valued security.

To boost payout the highest, a cash dividend choice need not be offered.  If the company is debt free, then a QSL vs stock dividend choice results in a virtually immediate cash payment to some of the loan dividend choosers.  the company can pay its earnings towards the new QSLs immediately.

To price the QSL dividend choice benefit, the principal amount is equal the cash dividend equivalent to the fixed fractional stock dividend (1/11th stock price if fractional stock dividend is 1/10th of a share).  The interest rate could be bid on, but that requires logistical support.  In healthy public companies, because QSLs guarantee no dilution of payment priority to the loan holder, every loan has an estimated organic (from operations) payment date.  Organic expected payment date can be used to set the Dividend replacing QSL interest rate to match the government bond rates of similar duration, adding a premium of, say, 20 basis points per expected year of repayment.

A high dividend choice not only allows a naturally efficient mechanism to separate shareholders into those that want to determine purpose of the enterprise vs. those that simply want financial benefit from the enterprise, but it also helps expedite purpose-aspirational shareholders to takeover the company without paying market premiums for it, but in a fair way to all other shareholders.  By bidding on dividend increase projects through QSLs, purpose aspirational shareholders encourage the corporation to boost dividend payout even more, and provide the benefit aspirational dividend choosers with cash payments.

A typical target dividend payout ratio for mature healthy public corporations (that pay dividends) is typically 50% of earnings.  It is 75%+ for Canadian Income Trusts.  When Income Trusts have poor performance periods where there payout reaches 100% of income, their market capitalization tends to drop below their book value, and yields go higher than P/Es.  The market is scared of high payout ratios, mostly because of fear that fixed dividends will be reduced rather than the fear that bankruptcy becomes imminent.  A variable dividend can allow the income trust to pay according to target earnings, and can payout 90%-100% of those earnings targets, because when it falls behind, it will naturally drop in stock price, and pay out less.  Their dividends become self adjusting.

Because of the obvious appeal of high dividend corporations, and the announced intentions of industrial icons (Bell Canada) to convert to Income Trust structure, the Canadian Government has effectively banned income trusts starting in 2011.  Variable dividends will allow converted Income trusts and  those corporations that wanted to be income trusts to boost payouts within management agendas.

Converting Public Corporations to Natural Finance - Part 1

Part 1 of 2.   This is the basic plan for converting a healthy public corporation.  It is relatively straightforward, offers free choice, but can overpay by not taking full advantage of natural finance principles to bypass the market corruption caused by the price difference between buying 100 shares vs 10M shares.

copied from manifesto.
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Converting a public corporation is voluntary by all affected stakeholders. It can be complete, partial, done in stages, and convert bonds, preferred and common shares. Once natural finance conversion has begun, no new bonds or preferred shares can be issued, and common share issues are not recommended..

Bondholders should be given first priority to convert. Secured QCSLs most closely fit the bonds the company considers too expensive for it. If all bondholders converted to unsecured QCSLs, they would all have enhanced security (demand lower yield) by the fact that they are first in line to be paid. Unsecured QCSL conversion for bondholders is essentially a cash redemption of bonds which is sometimes an enterprise right attached to some bonds. Secured QCSLs also offer better security to converting bondholders because in a distressed bankruptcy type scenario, they get theoretically 100% of principal, and they also receive high yields including a non taxable depreciation coupon. Those bondholders that do not convert, continue to have a fixed obligation paid before QCSLs, including principal at maturity, but they lose relative priority in the event of bankruptcy. A net positive to convert. Even when converting to natural financing in a distressed enterprise situation, if the conversion buys a few years survival, bondholders are substantially incentivized to convert. Better value to bondholders through natural finance, means lower borrowing costs to the enterprise.

Preferred shareholders are the only group that are economically-forced to convert in order to keep their relative security and payment regularity. Secured QCSLs match the payment regularity most closely. Non maturing Preferred shares are in fact a scam on its buyers, because the principal is never repaid. The odds that a non-liquor company will eventually (or within 200 years) go bankrupt are over 99.9%. Preferred shares tend not to have sufficient premium over bonds to understand that risk as properly considered. From the enterprise's perspective, paying a pre-profit coupon inflated by the inverse of its untaxed profit rate is equivalent to a preferred coupon. For example, at a 25% tax rate an 8% bond coupon is equivalent after tax to a 6% preferred share coupon (for same maturity date). From the investor perspective, forcing the exchange is forcing a net benefit of additional bond security, and forcing a net benefit is a gift. In most countries, on average, there is an equivalent after tax return to the securities as well. Offering the same optional conversion options to (converted) bondholders after the exchange, provides the same optional choice to preferred shareholders.

Common shares can be converted by either an internal “takeover” bid by management, a partial substantial issuer bid (bid for up to x shares). A company with net assets of 500K, making 100K per year, 10000 shares outstanding, and P/E of 10 has a $100 share price. If half the shares are sold in exchange for QCSLs loans at 10%, then after 8 years (QCSLs are repaid), without any operational improvement by the company, net assets are back to 500K, and the 5000 shares remaining at a P/E of 10 are worth $200. Every rational person who doesn't have direct oversight of management, and therefore cannot vouch for its confidence, would prefer to hold QCSLs (ignoring tax differences) because they are paid faster and more certainly even if the return is the same. From the enterprise perspective, if it can pay less than 10% interest rate (almost certain given profile), then it is net positive to the enterprise and remaining shareholders. Most successful public corporations should be able to achieve natural rates close to “riskless” government bonds (under 5%-6%).

Pensions are a scam/motivational technique on employees designed to keep them needing work. There are tax advantages for both parties, but administration fees and restrictions on cashability are net negatives compared to direct loans/deferred compensation. A pension system can continue under natural financing and invest its assets back into QCSL backed projects, but management may find employees willing to invest more if they provide them with higher returning and more flexible direct deferred compensation.

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The Modigliani–Miller theorem is false

The Modigliani-Miller_theorem states that dividend policy doesn't matter.  The basis for that is that a $50/share company that pays a $1 dividend, might become worth $49, but the investor got $1, so the investor still has $50 total worth of economic value.

If that same $50/share company gives an absurdly high non-cash dividend of 1 share to every shareholder, then the share value drops to $25/share, but shareholders have twice the shares, so still have $50 of value.  The offer is a complete waste of time to all involved because the outcome is identical to offering no dividend at all.

The same offer as the last, but this time the shareholder is offered the choice between a $25 cash dividend or 1 bonus share.  If 80% of investors choose the cash option, then the company will have paid $20 per share in dividends.  Its new capitalization per share is still (300/12) $25, and both those who chose to accept cash or shares have $50 of value.  However, the choice itself is of extremely high value to shareholders, and at least of obvious greater value than no choice at all.

So dividend policy obviously does matter.  Modigliani–Miller theory is management serving.  It is used to preserve their right to run the company into the ground instead of ever paying the investor back.  Their mandate to serve shareholders is a minimum satisficing one, instead of a passionate one.  A foundation of natural finance is that the only ones who should want ultimate purpose-holding (right to unlimited profits) authority is executive management, because their agenda subjugates any mandates they pretend to have.

The specific real world flaw of Modigliani–Miller theory is that all investors necessarily want to continue investing, and if given cash and a decision would reinvest in the same company at current market prices.

Note that any firm (worth $50) that offered shareholders the more reasonable (from management's greedy perspective) regular option of a dividend of 1 share per 10 shares owned, or $4.55 per share, roughly a 9% (1 - 10/11)  yield, would even if maintaining theoretical shareholder value,  actually significantly improve shareholder value by making share holding more attractive (only real source of share price increases) to buyers.  The share price increase would be even more beneficial for those that take share dividend over cash dividend.

Proof that Dividends matter
The choice of a stock or cash dividend, under Canadian tax law, offers in the stock option, 0 tax, liquidity and transaction cost issues.  If everyone chooses the stock dividend, there is no impact on the market value which management cares about, but is irrelevant to investors.  Even though there are tax cost from accepting cash dividend, there is also a corresponding future tax bonus from the reduction in market cap.  The first proof that Dividends matter is that most rational people would choose the cash dividend despite the theoretical inferiority of receiving it.  Public companies sometimes approximate this choice with DRIPS which are inferior to the choice because they may (do everywhere I know of) incur non-deferred tax costs for those that choose the option closest to a stock dividend.  50%-85% (believe higher end) of investors choose not to reinvest.  This proves a market appetite for dividends.

In the case of banks, future earnings expectations are based principally on book value, as it makes money from its money.  When it issues dividends, it reduces both its book and market value by the dividend amount, and so affects its future earnings projections.  Since most healthy banks trade above book value, the second proof that Dividends matter, apparently in favour of not paying them, is that market price as a function of book value and earnings optimism, drops by more than the cash dividend payment amount.  Yet this again proves a market appetite for dividends.

If the dividend choice (cash or stock) is significantly above earnings, for example both of the above ($50) examples, then book value and market value will both converge to each other, and converge to 0 if the dividend is continuous. For a $50 stock, and a 1 share for share dividend choice, the capitalization per share in each successive period halves [25, 12.5, 6.25, 3.125...], excluding  continued earnings contributions.  When companies trade below book value, then counter-intuitively, paying a high dividend increases shareholder value even if it decreases corporate survivability.  Trading below book value, is the market telling the corporation it is incompetent in managing its assets, and telling it, it should return investor capital.  The third proof that dividends matter is that since corporate capitalization goes to zero as a result of high dividend choice, Those who choose the dividend realize full theoretical capitalization payments in cash, while those who choose shares risk losing the full capitalization if bankruptcy results.  Whenever management chooses not to pay dividends it asserts its privilege to bankrupt the company without ever returning capital to shareholders.  Proof that traditional corporate structures are corrupt is that management asserts its privilege to power, salaries and longevity of the company over its mandate to maximize shareholder value.  Minority shareholders do not hold the democratic power to direct purpose of the corporation, and so are merely passive beneficiaries who are deceived by illusions of possible future dividends.

Note that the above offer of 1 share or equivalent cash dividend per share does not necessarily lead to a decrease in capitalization, much less bankruptcy!  A $50/share company with $5 in earnings (10%) maintains its capitalization if only 20% of investors choose the cash dividend.  The shareholder that chooses dividends each period will have collected (1023/1024) $49.95 over 10 periods, while his percentage of ownership will have decreased by 1/1024th.  Excluding the timing of tax payments, can be a net 0 tax benefit as well: capital losses offset dividend gains.

Very high dividend choices provide a natural, mathematical achievement of ideal perfect competition models for capital transfers, which imperfect markets corrupted by limited demand, supply, and information, and further corrupted by power, privilege and policy cannot achieve.