As an example, Ford Motors recently reinstated its dividend. It still has a lot of debt and a high debt-equity ratio. Its bonds are still rated as junk. Why would a company like this spend its cash paying dividends? Wouldn't the long-term value of such a company be improved more by paying down debt?
A simple response is that it's a good political/strategic move. Ford have effectively said, "We know we still have debt, but we think the long term future is so good we can go back to paying dividends." It builds investor confidence and attracts new money.
It can also be seen as a way of Ford indicating that they believe the type of debt (regardless of the amount) is okay for them to carry.
5They can afford to err on the side of risky, as the US government has implicitly guaranteed the survival of "too big to fail" companies like big banks and automakers with the full faith and credit of the US gov't. Jan 21, 2012 at 18:06
Ford paid off a tremendous amount of debt prior to reinstating the dividend. While they still have a sizable amount of debt on the balance sheet, they've been able to refinance this debt to a much more affordable point. Their free cash flow + cash on the balance could enable them to pay it off in the very near future (12 - 16 months).
Most auto companies have debt on their balance sheet if they choose to offer financial services.
Their overall credit rating (if you really think such things are valid) has also improved.
Generally speaking, I agree its a poor idea to give money back to shareholders if you have high-interest bearing debt.
One reason a company might choose to pay a dividend is because of the desire of influential stockholders to receive the dividend.
In the case of Ford, for example, there are 70 million shares of Class B stock which receive the same dividend per share as do the common stock holders. Even though there are 3.8 billion shares of common stock, the Class B owners (which are Ford family) hold 40% of the voting power and so their desires are given much weight.
The Class B owners prefer regular dividends because if enough were to sell their Class B shares, all Class B shares (as a block) would have their voting power drop from 40% to 30%, and with further sales all special voting would be lost and each Class B share would be equivalent to a common share in voting power. Hence the Class B owners, both for themselves and for all of the family members holding Class B, avoid selling shares and prefer receiving dividends.
While Ford and the other auto makers have a bad few years, some companies want to have a cash dividend. It appeals to certain investors. Others have tried to avoid dividends: Microsoft didn't start until ~2003; Apple only from mid 80's until mid 90's.; Google never has had a cash dividend.
The desire to keep the dividend, or even to increase it, make some companies continue the practice; even when it doesn't make complete sense. Here is a list of stocks that have INCREASED their dividend for the last 25+ years: http://www.dividend.com/dividend-stocks/25-year-dividend-increasing-stocks.php Some have had good years, others bad years, in the last 25+ years.
Having a debt on a balance sheet does impact the capability and willingness of the company to pay dividend. But more than this it depends on the profitability of the company.
If the company is profitable, there is no reasons why it's share holders should not be rewarded. If the company does not have debt, lot of money and no profit, normally no or a symbolic dividend is paid.
It is a good move by Fort. Dividend is the effective way of paying something back to the shareholders.