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