Dividend Policy
Microsoft vs Berkshire Hathaway
Topic of Discussion
Dividend Policy at Microsoft and Berkshire Hathaway

Years ago, a financial media expert on CNBC, Mary Richards, said that
“the big question weighing heavily on everyone’s minds was whether
Bill Gates at Microsoft and Warren Buffett at Berkshire Hathaway (the
two richest CEOs in the World) would ever initiate a pay out of dividends
at their respective companies.”  Ms. Richards disagreed with the
expectation of many shareholders who were waiting for a dividend
payout.”  Ms. Richards went on further to say, “If it ain’t broke don’t fix it.
Microsoft and Berkshire should continue to retain all earnings and hold
large sums of cash for future investments.”
The second guest on the show, Alice Morgan, was an expert in Modigliani and Miller’s “dividend irrelevancy” proposition and said to Ms.
Richards, “I think that we are wasting our time about whether or not Microsoft and Berkshire should pay dividends. It doesn’t impact
stock prices.  Moreover, those shareholders who don’t like Microsoft’s and Berkshire ’s dividend policy can create “homemade
dividends.”  There are options to pursue such as the “residual dividend” policy.  Finally, I believe Gates and Buffett should maintain their
current capital structure as being optimal.”  

#1. Comment on Ms. Richards suggestion of not paying any dividend.  What are the pros and cons of such a policy at Microsoft and
Berkshire ?
Ms. Richards made it clear that she does not believe a dividend should be paid by either company.  She must believe that these
companies can internally invest the capital to grow their business because it is not a good financial move to sit on this amount of cash.  
It either should be working to grow the business, or being paid to investors in the form of a dividend.  

Some of the pros of dividends are they are attractive to investors because they receive a cash return, stock price usually increases with
the announcement of a dividend increase, dividends can absorb excess cash flows, cash cow companies who do not have a need to
internally reinvest this capital can pay it out to the investors and investors can opt to automatically reinvest the dividend to increase their
position in the stock.  Cons involve double taxation (taxed as earnings and taxed at the capital gain rate for investors), dividends can
reduce internal sources of financing, companies are expected to keep increasing dividends (even in lean years where they may have to
borrow to pay the dividend), if the dividend is ever cut it harms the stock price (even if it is for a strategic internal growth project) and
starting to pay a dividend is a negative sign to Wall Street because they could believe the stock is done growing.  All of these pros and
cons apply to both Microsoft and Berkshire.  

#2. What did Ms. Morgan mean when she said that shareholders who don’t like Microsoft’s or Berkshire ’s dividend policy can
create “homemade dividends?”
A homemade dividend can occur from the investor that owns a stock that does not pay a dividend.  If they want a 2% dividend, they can
sell 2% of their holdings.  This works well for investors of companies that do not pay a dividend, and whose investors like taking their
dividend in cash.  This does not work if the investor wants to reinvest the dividend, since that would be equal to not selling the stock in
the first place.  

Below is an example of the homemade dividend:
Investor owns 500 shares of EBAY at $30.  The investor wants a 1% dividend, they can sell 5 shares for $150 in cash.   In year 2 they will
likely also sell 5 shares (rounding 4.95 up to 5).  

#4. Comment on whether Microsoft’s or Berkshire’s respective share price will suffer if dividends are not paid at Berkshire, or not
continued to be paid at Microsoft, while the companies continue to hold such high amounts of cash and short term marketable
Berkshire’s share price will not suffer because their stock has not paid a dividend in the past.  They have reinvested the capital
internally, and have seen great returns that have beat the market.  Berkshire investors are not looking for a dividend either, or they would
not have tied up a minimum of $130,000 in the stock.

Microsoft’s share price will likely suffer due to the fact that the street has been expecting them to increase dividends.  They sat on very
large amounts of cash for so long, not reinvesting it, nor paying it out to investors that the investment community grew tired of Microsoft.  
Microsoft regained interest in their stock by paying a dividend, including a one time 9% dividend.  If Microsoft stopped paying a dividend,
and did not have internal projects lined-up, their stock will likely decrease in value upon news of the dividend cut.  

#5. In your opinion should either Microsoft or Berkshire pay a dividend?
Microsoft should pay a dividend, but Berkshire should not.  Microsoft has proven that they cannot find projects to invest their capital into,
and in that case, I believe they should pay a dividend.  I also believe if Microsoft pays a dividend, it will be more attractive to a larger pool
of investors.  Berkshire has been very successful in finding new companies to acquire, and have always had a good return on their
investments.  Berkshire should continue to be aggressive in purchasing new companies, and earning their investors a better return
than the market.  
#3. Ms. Morgan referred to a residual dividend policy.  How
would a residual policy work for both Microsoft and Berkshire
in terms of the dividend per share the companies could afford
to pay, referring to the most recent financial information you
have access to?
The residual dividend policy is used to finance new projects
through equity that is internally generated.  Dividend payments
are made from the equity that remains after all the project capital
needs are accounted for.  This remaining equity on the balance
sheet is known as residual equity.  It is advisable that those
companies, which follow the policy of residual dividend, should
maintain a balanced debt/equity ratio.  This does not exist at
Microsoft because they have no debt, but does apply to
Berkshire. This policy is feasible for Berkshire to follow, but not
advised because Berkshire should not pay a dividend.  If
Berkshire was to follow this policy, they would keep a 28% ratio
of debt to equity.  
Relevant Links
Rosario Acero S.A. Case Study
Deluxe Corporation Case Study
Euroland Foods Case Study
Hilton ITT Wars Case Study
Burn Rate Financial Metric