Question

C. In the 2020 accounting year, investors made a number observations in terms of certain decisions some corporations were taking:

(i) The board of directors of some manufacturing and services companies decided to pay stock dividends instead of cash dividends;

ii) On the other hand, the board of directors of majority of companies within the ICT industry decided to pay special cash dividends;

(iii) It was also observed that some the management of some companies had decided to repurchase shares while others were engaging in stock splits.

What could be the reason for these three decisions and choice of dividend payments by the boards of these companies and what will be the effect of such decisions on the outstanding number of shares and the share prices of these companies?

Answer 1

i) Stock dividends instead of cash dividends :

This is done mainly,

A) To increase no. of shares outstanding

B) To minimise distribution of cash to the stakeholders.

Effect :

No. of shares outstanding increase. But stock price decrease as market capitalisation remains the same.

ii) Payment of cash dividends :

This is done when company wants to transfer economic value to its shareholders instead of using the money for company's operations.

Effect :

No. of shares outstanding remain same but stock price reduces by approx. the same amount as dividend.

iii) Repurchasing of shares :

Company generally repurchases shares to consolidate its ownership. It is also done to reduce the cost of capital and to benefit from undervaluation of the stock.

Effect :

As outstanding shares are repurchased, no. of outstanding shares in the market will reduce. This will increase the share price.