Listing Segments

Listing segments are classifications of listed companies on BM&F Bovespa according to Corporate Governance practices. To be part of a listing segment companies have to voluntarily adopt best practices in Corporate Governance that are not required by legislation. The listing segment acts as a seal of quality that may help the company attracting funds and investors signaling high standards of transparency and accountability.

There are five listing segments. One of them is named Tradicional (Tradicional) and is nothing else than what legislation requires. Other is Bovespa Mais (Bovespa Plus), a special segment to small companies. In this text I will not analyze Bovespa Mais, that may be a topic for future text.

The more important listing segments are Nível 1 (Level 1), Nível 2 (Level 2) and Novo Mercado (New Market in a literal translation) in order of stricter requirements. The table above shows the more important features and is extracted from BM&F Bovespa website, not available originally in English (I did the translation myself):

You may consult the complete requirements in the listing regulations:

Novo Mercado regulation

Nível 2 regulation

Nível 1 regulation

Basically, the main difference of Novo Mercado and Nível 2 is the classes of shares allowed. Companies in some industries may have legal restrictions of foreign control (airline companies, for example) and cannot float common stocks in excess of what the legislation states. In this case, the company may want to adopt a high standard of Corporate Governance but cannot issue only common stocks, so they opt to be listed on Nível 2.

The creation of Novo Mercado was a major milestone to Brazilian Stock Market. It was created in 2000 based on experiences in other markets like Neuer Markt in Germany. The first company to opt for Novo Mercado was CCR S.A and nowadays there are 131 companies on Novo Mercado (see here). Most companies that went public after 2002 (like CCR) opted for Novo Mercado and the higher standards of Corporate Governance helped to unlock the public offerings market in Brazil.

Mandatory Dividends in Brazil

In Brazil, according to Limited Companies Act (Law nº 6.404, article 202), limited companies have to set a minimum mandatory dividend not lower than 25% of the net income, but it is possible to pay less or none dividends than the minimum in some cases. The question is: what are the real effects of this regulation?

In an article published in The Journal of Corporate Finance, Theo Cotrim Martins and Walter Novaes analyzed this question in respect to Brazilian market in the period 2005-2009. This discussion is on the context of laws that protect the minority shareholder and the link of this theme with financial development of a country. The mandatory minimum dividend would prevent the controlling shareholder of not paying dividends to use cash as they wish, but may produce the adverse effect of reducing free resources to be invested. Only five countries have this kind of regulation, Chile, Colombia, Greece, Venezuela and Brazil.

As mentioned, Brazilian limited companies have to pay at least 25% of the net income in dividends, but there are legal ways of paying less. One is through the formation of reserves. The article’s author interpreted this as a legal maneuver but this is also an obliged practice by the same law nº 6.404 (article 193). The companies have to reserve 5% of their net income to Legal Reserve before any other destination. The Legal Reserve cannot exceed 20% of the Social Capital (the part of shareholder’s equity represented by common and preferred stocks). Thus, companies with Legal Reserve below the limit must reserve part of their profit. The payout ratio is calculated using the net income after Legal Reserve, thereby the legal minimum payout in this case is 23.75% (i.e., 25% over 95%). On average, 41.49% of the companies paid dividends below the mandatory (25%), but that is because the Legal Reserves, as explained.

On average, 21% of profitable companies do not pay dividends, using the legal breach to retain earnings if the directors consider that this is of the company’s best interest. However, this practice is not persistent because of article 111 of Limited Companies Act, which grants voting rights to preferred stocks if the company fails to pay dividends for three consecutive years (or less, if the by-law thus states), right that carry on until the company pays cumulatively the due dividends.

The activity of Comissão de Valores Mobiliários (Brazilian Securities and Exchange Comission) may curb the undue retention of dividends as those situations have to be analyzed by CVM and may result in penalties if the retention is not justified.

Therefore, companies seek legal breaches to pay fewer dividends but are restricted by the law. And what is the economic effect? Public companies in Brazil paid, in the period of analysis, dividend yield of 2.29% compared to 1.38% in the United States, where there is no such law. Even taking in account that American companies buyback more stocks, the yield would be 1.9% still below what Brazilian companies pay. Despite the law, fewer companies pay dividends in Brazil compared to United States, 57% vs. 67%. Differences in companies’ size do not explain this difference of policies. More profitable companies are more prone to pay dividends in Brazil as in the United States. In Brazil, however, the payment drops more abruptly analyzing less profitable companies.

Another question is if mandatory dividends reduce capital investments in public companies. To analyze this, the authors use a two-stage regression, in the first determining the probability that a company will pay dividends and in the second stage using this factor to analyze capital expenditure. The result is that dividend payment does not affect the investment capability, thus, the obligation to pay dividends does not seems to affect corporate financial decisions.

Therefore, Brazilian dividend law increases the payment of dividends to profitable companies, reduces the payment of less profitable companies and does not seem to impact negatively the corporate investment.

One last detail, companies may voluntarily stipulate a minimum dividend payout higher than 25% in their by-law. Most companies choose 25% though.

Mandatory dividend rules: Do they make it harder for firms to invest?

Theo Cotrim Martins e Walter Novaes.

Journal of Corporate Finance. Volume 18. Ed. 4. 2012

Brazilian preferred stocks

Preferred stock is a type of stock that has preference over common stocks regarding the payment of dividends. In international markets, preferred stock is considered a hybrid instrument, a shareholder’s equity security with fixed income characteristics.

In Brazil, what we call preferred stock is a common stock with different voting rights. Companies in other stock markets may create Class B stocks with superior or inferior voting rights. Brazilian preferred stocks (i.e. Class B stock) is a type of stock which has fewer or none voting right, having some kind of advantage over common stock (Class A stock, if you will) in receiving dividends.

The Lei das Sociedades Anônimas (Limited Companies Act) states three possibilities:

A) Priority of receiving mandatory dividends (another specific characteristic of Brazilian stock market), the dividend to preferred stock has to be at least 3% of the company's shareholder’s equity.

B) Right to receive dividends at least 10% higher than those paid to common stocks

C) Tag Along of at least 80% and same dividends distributed to common stocks

In the case A, the company first decides how much to pay in dividends. Then first the preferred shareholders receive 3% of the company shareholder’s equity in dividends. If there are more dividends to be paid, the same amount is paid to common stocks. If there are more dividends to be paid, then it is equally distributed to common and preferred stocks.

The company’s by-law must state what the advantages granted to preferred stocks are.

Examples:

A) Petrobras (NYSE: PBR.A to common stock and NYSE:PBR.B to preferred stock) states that preferred stocks have the right to receive at least 5% of preferred stock capital and at least 3% of their shareholder’s equity

B) Bradesco (NYSE:BBD to preferred stock) grants 10% higher dividends to preferred stock. The bank also grants 80% Tag Along (Case C) but it is because of BM&F Bovespa’s special listing segment rules (Nível 1, i.e., Level 1). In a future text I will write about those special segments.

C) Itaú-Unibanco (NYSE: ITUB to preferred stock) grants to preferred stock Tag Along of 80%. Additionally, the company grants to preferred stocks the priority of receiving the yearly minimum dividend. The dividends paid to common and preferred shares are the same.

Additionally, preferred stocks have priority if the company is liquidated. Some companies grant voting rights to preferred stock. Vale (NYSE: VALE to preferred stock) gives to preferred stock the same voting rights except for elections to Board of Directors (Conselho de Administração in portuguese). Vale’s minority shareholders may, in a separated election, elect or remove one member to Board of Directors if they represent at least 15% of the total common shares or 10% of preferred shares. Preferred shareholders have the right to elect or remove one member to Fiscal Council.

Vale has another special case for preferred stocks. There is a “special” preferred share owned by the Brazilian Government that has veto rights in some subjects. Consult the company’s by-law, article 7, to see what those subjects are.

Law nº 6.404 (Lei das Sociedades Anônimas) limits the preferred stocks to 50% of the company’s capital. Brazilian companies usually have a concentrated ownership and preferred shares are issued to raise capital without losing control rights. Because of this, the law restricts the number of preferred stocks that may be issued.

Since 2004, Brazilian companies that go public are usually choosing a capital structure with common stocks only. It is an important change in Brazilian stock market and a great advance in terms of Corporate Governance. More about those subjects in future texts in this blog.