The Unfunded

Brad DeLong takes issue with Daniel Gross's column questioning why GM and Ford are continuing to pay their shareholders substantial dividends. DeLong writes:

According to Gross, Ford has $23 billion in cash and yet a stockholder's total equity value of only $18 billion. If that is true, why not spend $18 billion on a special cash dividend?

The reason is that these figures are essentially incorrect. They are derived from Ford's balance sheet statement that does not reflect liabilities for unfunded pensions and retiree medical benefits. According to a Reuters story on May 5, these liabilities are in the respective amounts of 12.3 Billion and, hold onto your hats, 32.4 Billion as of the end of 2004. One has to dig through Ford's financial statement filed with the SEC to find this bland explanation for the omission of the liabilities from its balance sheet:

Note 10.

* * * * *

Company Contributions

Our policy for funded plans is to contribute annually, at a minimum, amounts required by applicable laws, regulations, and union agreements. We do from time to time make contributions beyond those legally required.

Pension: As of April 2005, we contributed $2.4 billion to our worldwide pension plans, including benefit payments paid directly by the Company for unfunded plans. We expect to contribute an additional $400 million in 2005 for a total of $2.8 billion. Based on current assumptions and regulations, we do not expect to have a legal requirement to fund our major U.S. pension plans in 2005. We also do not expect to be required to pay any variable-rate premiums for our major plans to the Pension Benefit Guaranty Corporation in 2005.

Health Care and Life Insurance: In April 2005, we contributed $200 million to our previously established Voluntary Employee Beneficiary Association trust ("VEBA") for U.S. hourly retiree health care and life insurance benefits.

In other words, these massive liabilities, which would entirely wipe out the shareholder book value of the company if shown on the balance sheet, are simply omitted. Of course, this does not mean that the company has no value. After all, the balance sheet does not reflect the company's goodwill and the stream of Ford's future earnings may be sufficient to take care of these benefit shortfalls. Since Ford has a market capitalization of $18.4 Billion, a figure that presumably factors in the pension and health care liabilities, on one side, and the goodwill value, on the other, the "market" apparently believes that Ford has, all things considered, a positive valuation.

Yet this analysis does not resolve the DeLong/Gross debate, although it would seem that DeLong's glib "why not pay out the entire value in dividends" is clearly unwarranted. The issue is far more complex: To what extent will the payment or non-payment of dividends impair the company as an ongoing operation?

If, for instance, in authorizing the dividends the directors significantly overestimate the company's ability to continue in operation and reverse its current fortunes, the decision to pay dividends could, in retrospect, be deemed to be folly, because, for instance, the payout might impair liquidity just when it was most needed to restructure the business.

On the other hand, it may be helpful to use dividends to keep shareholders relatively contented. A failure to authorized dividends that runs counter to shareholder expectations could be viewed very negatively by the market (such as might be the case if the market concluded that the failure to pay dividends was because the financial condition or prospects of the company were more dire than management had previously let on). A radical drop in market capitalization could, in effect, turn into a run on the bank.

If pressed to take sides, I would go with Gross, but that's only because DeLong is simply too doctrinaire as to the amounts that should be paid out. That being said, however, I am not at all certain that the dividends are entirely too high.