Payment of Stock Dividends (Bonus Shares) | Advantages and Disadvantages

Payment of Stock Dividend (Bonus shares)

Under stock dividend, the board of directors authorize the distribution of bonus shares to the existing shareholders. These additional shares issued are called stock. Thus, stock dividend is paid in the form of stock. Payment of stock dividend has the effect of increasing the number of shares of the company. Suppose, a shareholder owns 200 equity shares when the company distributes a 4 per cent stock dividend. Then the shareholder will receive 8 additional shares.

Stock Dividends

Stock Dividends – Advantages and Disadvantages

Advantages of Payment of Stock Dividend (Bonus Shares)

Payment of stock dividend helps secure the following objectives.

1. Conserving cash

When the company does not find sufficient amount to pay cash dividend, it may pay stock dividend. Stock dividend is paid without using up cash and the cash so saved may be used for the expansion of business operations. A company may retain cash for financing its projects without resorting to external borrowing.

2. Indicating higher future profits

Generally, payment of stock dividend indicates higher future profits. After the payment of stock dividend in the form of issue of additional shares, the earnings of the company should increase. If profits do not rise, there will be a dilution in the earnings. As dilution of earnings is not desirable, stock dividends are declared only when the directors expect rise in earnings to offset the additional shares.

3. Raising future dividends

Stock dividend helps in raising future dividends of the existing shareholders. If the regular cash dividend is continued after an extra stock dividend is declared, the cash dividend available to shareholders in future will increase. For example, a shareholder has 100 shares in a company and the company declares Re.0.50 as regular dividend and a six per cent extra dividend. Then the shareholder will receive Rs.53 (100 x 0.50+ 6% of Rs. 50) the increase in dividend being Rs. 3.

4. Psychological effect

Declaration of stock dividend creates a psychological effect in the minds of the shareholders that the firm is competitive and is profitable to them. The stock dividend creates a positive effect in the market. This encourages more and more investors to invest in equity shares thereby raising their market price.

5. Maintaining proportional ownership for shareholders

Stock dividends help in retaining proportional ownership for shareholders. As and when the company issues further shares, new investors purchase shares. This will have the effect of reducing the ownership for the existing shareholders who do not have funds to buy further shares. But stock dividend gives additional shares to the existing shareholders thereby retaining proportional ownership for them.

Inspite of the above advantages, stock dividend has certain evils.

Disadvantages of Payment of  Stock Dividends

1. Over-Capitalization

If a company, declaring sock dividend, does not increase its earnings proportionately, then it may result in over-capitalization.

2. Brings Pressure on the company

Stock dividend increases the expectations of the shareholders from the company. Their expectations about the company’s profitability and future profits from the shares are rather high. So, this brings pressure on the company to satisfy the shareholders.

3. Scrip dividend

When the position of the company for declaring dividend is not sound, the company gives to the shareholder a temporary promise to pay a dividend at a future date. Generally, scrip dividend is in the form of a promissory note with interest. It can be provided as a security to the banker for raising loan.

4. Property dividend

Under extraordinary situation the company pays property dividend to its shareholders. Property dividend is distributed in order to prevent the prices of shares becoming nil. Usually, property dividend is paid only once in the life time of the company.

5. Bond dividend

Bond dividend is paid instead of paying cash dividend. The purpose of payment of bond dividend is to conserve the cash and also to make payment of cash dividend applicable to preference shareholders.

6. Special dividend

When the company is retrenching its operations, it is not in a position to declare cash dividend. In this situation, special dividend is paid as a device to return the capital to the shareholder in a gradual manner.

7. Optional dividend

As the name itself implies, optional dividend is paid either through cash or through stock. When the company is not able to pay cash dividend because of appropriation of cash for some other use, it may decide to pay stock dividend. In short, optional dividend is choosing between the cash dividend and stock dividend.

8. Depreciation dividend

Payment of depreciation dividend is not a healthy practice on the part of the company. Depreciation dividend pertains to paying a small amount to the shareholders with an intention to reduce capital.

9. Dividend from capital surplus

Investment in equity shares is rewarding only when the company pays stable dividend over a period out of current earnings. But under certain circumstances, the company pays dividend out of capital. Payment of dividend out of capital is allowed only under the following circumstances:

  1. The Memorandum and Articles of association allow payment of dividend out of capital.
  2. Profits are received by the company in the form of cash.
  3. Surplus arises out of revaluation of assets.
  4. Distribution of dividend out of capital is in such a manner that it does not affect the creditors.

10. Dividend from appreciation

Sometimes, the company sells its assets at a price which is more than their book value. The surplus available on account of such appreciation may be used by the company for paying dividends.

11. Liquidation dividend

Liquidation dividend is paid by a company at the time of its liquidation. If the company is dissolved, all its assets are realized. Out of such realization, the liquidation dividend is first paid to the bondholders and debenture holders. Then after paying preference shareholders, equity shareholders may be given such amount of dividend.